The Most ‘Obvious’ Recession In History

“Obviously unsustainable.”

That’s how one market participants described the dynamic whereby purported savings “buffers” and “excess” cash built over the pandemic support consumer spending and prevent the US economy from sliding into recession.

Initially (where that means last year), I was sympathetic to that thesis, but it became harder and harder to countenance as inflation rose and consumption habits shifted to account for the soaring cost of necessities. As detailed in “The Sad, Sad Story Of $3 Trillion In Pandemic Savings,” the lowest-income Americans have less in available cash now that they did at the end of 2019, not more (figure below).

And while the middles class has $930 billion in “extra” liquid savings compared to pre-pandemic levels, that’s just 29% of the total COVID-era increase.

Bottom line: Some 70% of the $3.2 trillion in “buffer” savings resides in the accounts of the top 20% of households, which have the lowest marginal propensity to consume. That’s more likely to support equities than it is consumption, but there’s a problem there too: Equities are a function of corporate profits, so if the top 20% of households use their savings buffers to invest in stocks, they may find the fundamentals lacking if the rest of society runs out of money to spend.

We’re already seeing evidence of this. Personal spending data for May was disappointing. Considering consumer sentiment plunged to a record low in June, it wouldn’t be surprising if consumption faltered last month too. In fact, it’d be surprising if it didn’t.

The writing is on the wall. In big letters. Micron this week guided a mile below consensus for its fiscal fourth quarter, citing weakening demand. The word “demand” came up 46 times in the company’s call, and quite a bit of the commentary was negative. “Near the end of fiscal Q3, we saw a significant reduction in near-term industry demand, primarily attributable to end demand weakness in consumer markets, including PC and smartphone,” CEO Sanjay Mehrotra told analysts. “These consumer markets have been impacted by the weakness in consumer spending in China, the Russia-Ukraine war and rising inflation around the world.”

That doesn’t bode well for discretionary spending, and neither did the collapse of talks around a deal for Kohl’s, which fell sharply Friday after citing “the current financing and retail environment” in explaining why an agreement with suitor Franchise Group couldn’t be reached. “There weren’t many people left who thought Kohl’s would actually be purchased in the present environment,” Vital Knowledge founder Adam Crisafulli wrote. In May, the company delivered very poor results amid a broader retail wipeout.

Also this week, Bed Bath & Beyond crashed after delivering a disastrous set of results which included, among other dubious achievements, an adjusted EBITDA loss nearly triple analyst estimates and gross margins that were 780bps short of the street. Anthony Chukumba, managing director at Loop Capital Markets, wasn’t forgiving: “They’re done. I mean, stick a fork in them.” CEO Mark Tritton was ousted in favor of Sue Gove who said, “We must deliver improved results. Our shareholders, Associates, customers, and partners all expect more.” (Meme stock investors expect more too.)

And then there was RH, which revised its outlook to account for “the deteriorating macroeconomic environment,” which CEO Gary Friedman described in blunt terms. “With mortgage rates double last year’s levels, luxury home sales down 18% in the first quarter, and the Fed’s forecast for another 175bps increase to the fed funds rate by year-end, our expectation is that demand will continue to slow throughout the year,” he said.

All of that is ominous. Consider that according to SafeGraph, which collects aggregated, anonymized smartphone location data, US retail foot traffic has fallen for seven consecutive weeks on a YoY basis.

You might argue that’s not surprising given impossible comps, but I’d say that’s precisely the point. The stimulus tailwind is gone. The savings buffers are evaporating and Americans’ shopping habits are adapting to the macro circumstances.

The figure (above) shows the breakdown by retailer. Note the outlier. As documented here in late May, America’s middle class is trading down. And that’s helping dollar stores to trade up. Shares of Dollar General rose more than 11% in June, for example.

It’s virtually impossible to make a case for a resilient consumer in the back half of 2022. I’d be inclined to suggest that anyone who makes such a case is being deliberately obtuse or else defines “consumer” by reference to income cohorts with lower marginal propensities to consume, which seems oxymoronic to me.

At this point, the best argument against the recession narrative (and thereby against the case for a wave of earnings revisions and margin shortfalls) is probably just that it’s consensus. That brings us full circle. When market participants start describing outcomes as “obvious,” that can be a contrarian indicator.


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9 thoughts on “The Most ‘Obvious’ Recession In History

  1. I’m very intrigued to hear how the Fed and the administration spin the narrative if/when we find the US in a confirmed technical recession in the near future. I was out at a local restaurant last night, nothing fancy, frequented mostly by tourists and upper middle class locals, I overheard two separate conversations commenting on how shocked folks were after looking at their 401ks, recessions have a psychological element to them, it feels like we are already in one and things keep deteriorating, news cycles will exacerbate this feeling of despair and doom. Dems will get wiped out in November and the Fed will pivot, but they’ll probably be too late to act again.

    1. Looking through my email feed today, the other “obvious” theme is that we are due for a trabeable bear market bounce.

  2. I drove up and down the entire west coast last week… lots of traffic, people pulling boats/campers, freight trucks everywhere, motels booked, restaurants busy with long lines.

    1. You should do this again in 6 months – say at Christmas time – and again next June. And we’ll see if you can discern any change in your impressions of the economy at large. If you can’t I’d say we survived the recession.

  3. H-Man, took the grand kids (15 and 17) on the annual pilgrimage to the Orlando parks. A hot dog ( boiled not roasted) cost $13, toss in water at $3.75 and your spending a fortune on pablum, This madness can’t last.

  4. This post reminds me of a series of posts that Ben Hunt at Epsilon Theory (h/t to The Heisenberg Report for turning me onto that a while back) has written about the importance of common knowledge — “common knowledge is something that we all believe everyone else believes.” It’s an essential concept in managing the expectations-driven game that seems to define Wall Street of late, and can often derail all but the best-laid and most-disciplined investment approaches.

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