An Economic Reality Check
Now, What Are You Going to do About it?
By Phil Mancuso
In the thirty-five years I have been in mortgage and real estate, I do not know if I have quite seen anything like the last few years.
How does one observe, measure, plan and trade around an entire economy that has been shut down for months, only to see it not fully re-open for well over a year? Then pumping unprecedented sums of currency into the system while continuing to navigate what has been an ever-widening wealth gap, which has only been made worse by said seizure and resuscitation? And once we have endured and accomplished all that, how do we finally expect to safely land that massive, ill-conceived and unwieldy ship? In two words; you don’t.
You don’t because the data with which decisions are made is stale and imperfect. You don’t because the numbers and the people interpreting those numbers have never lived through these conditions, nor have they navigated an economy that seemingly becomes obsolete daily thanks to the internet and machines. You don’t because our economic behaviors change daily, swiftly and without warning. You don’t because the Fed knows two speeds; run like hell or smash into a wall at top speed. And lastly, you don’t because the Fed had it right to begin with, inflation was transitory.
Our Economic Health
In fact, our economic health has been transitory since the 1980s, buoyed by events like stock and housing bubbles, Baby Boomer inheritance bonanzas, intra-year tax cuts, QE-infinity and most recently COVID stimulus checks. Guess what has not nurtured that health? Income. Pull any income chart over the last three decades and you will find it has not moved much, even with the recent boon in wages. So, when that bonus money runs out, so too does prosperity. I have said for several decades that rates are never going up and I’ve yet to be wrong. That bell has now tolled for much of America and the numbers are only starting to show it, but on the streets we can feel it, on Twitter we can see it. You do not have such massive discourse or discontent when all is well. The bond market, which always sees that forest through those trees has been screaming it. Mainly because all the hints have been hidden in plain sight.
ISM prices paid peaked in June of 2021, yet CPI only breached a 5 handle last month. In fact, you would have to go back to April 2020 to find a worse level than this past December’s ISM price component. Further, we had two consecutive negative quarters of GDP, which formerly was considered a recession before we redefined the term and we are now predicting, even trending back to that in the second half of this year. Or, maybe it is as simple as the good ole’ eye and smell tests. Malls were packed in the Summer of 2021, yet today they are often found empty. I have asked many retailers, builders, tradesmen and others and they have all said the slowdown is palpable. Never mind asking your friendly neighborhood loan officer. And there is that little thing about bank failures. In fact, three of the four biggest failures on record, and yes that includes the depression and 2008, just happened recently.
Everything is fine. Nothing to see here.
But what about all these high prices? In a word, scarcity. The Fed is trying to fight demand-pull inflation. That is the inflation that rate hikes can tame. But how do we have demand-pull inflation in the absence of historically normal supply levels? Unpopular opinion: we do not have inflation; we have a goods and services shortage. Monetary policy cannot fix that problem. The million-dollar question is will supply ever return? I have heard arguments from very credible supply chain experts, on both sides. On the not so bright side, one such compelling argument was that the western consumption model is on life support.
We are running out of everything and will be forced to live like people in Europe and the far
East with fewer, better, and more expensive things. There will be more customization, smaller closets and homes, steak dinners becoming more the exception for special occasions or for the wealthy.
The Near-Term Inflation Outlook
There was a time when things were built to last and not cheap and disposable. We have too many people and too few resources. I would imagine shortages also have not been helped by four record years of factory fires and explosions, highlighted by a 129% jump in 2021. What if we go back to one-car households? Smaller houses? Less consumption? We had two TVs in our house growing up and one of those was a small portable TV. Now some houses have a dozen. In fact, my first rear projection TV cost over $5,000 in 1998 dollars. That would buy me ten or more today in 2023 dollars. The good news is we would have a long way to go to return to a high price-low consumption model.
So, what if prices do not go down en masse? The worst outcome is stagflation, high prices, bad economy. It is very rare. In fact, it has only happened one time and it was driven by a gas shortage.
The good news is prices across many measures are coming down, so that outcome seems unlikely. In fact, if you discount the last year or so of price increases and drill down over a longer-term view, you will find that many if not most household items are actually very cheap using relative dollars, especially electronics. TVs, computers, phones, vacuums, etc. are in fact incredibly cheap adjusted for inflation. My first computer was about $4,000 all in 1980 dollars. Even most cars are relatively cheap. A simple Google search of a 2002 Ford Mustang will tell you the MSRP was $24,390. That same car today is $27,770, not even a 1% annual price increase. At the same time, a 2002 Lamborghini Murcielgo stickered at $273,000, today an Aventador starts at $789,809.
Let’s talk about food and the much-publicized price of eggs. Per the BLS website, a dozen eggs cost $2.20 in March of 2008 and last month they were $3.27. That is a 2.5% per year increase and essentially in line with the Fed mandate. Not what you expected?
In the end, what does all this mean for the near-term inflation outlook? Getting back to the internet and machines, here is the punchline. Information and automation are price and wage killers. In the absence of outside influence or unexpected events, prices and wages cannot go up. It is called competition and it is more global than ever.
Free economy and self-interest will continue to drive this march to the bottom for anything not valuable or scarce. My grandmother had to pay a 300% markup on a gallon of milk because she could not order it on Amazon to be droned in on a 5% markup.
Make it up on volume. That is what information and automation do. That is what globalization does. This is not a guess, it is not a hunch, it is a fait accompli.
Now What?
So, all that is the reality check. Now what do we do about it? We already did. Step one to solving a problem is knowing you have one. Real estate is not going away. God is not creating more land. People will always need a place to sleep. And all that money the Fed has printed for the last two decades has not fully come out of the system as I have previously alluded to. Not even close. More folks have hung on to that money than in previous cycles and they are still spending it. A lot of it. And that is what is messing up the numbers.
All this money we printed was not distributed disproportionally and we are not spending it proportionally. The price elasticity of high-end items like watches, cars and big houses is staggering. How does the Fed fight that without killing everyone else? I would argue they do not. Higher rates will not stop people from buying things that are excessively expensive because they have cash and they need places to put it and for many that answer is not the bank.
As always in real estate: LOCATION, LOCATION, LOCATION. As always in the markets: Bulls and Bears make money and pigs get slaughtered. There is plenty of money to be made in the markets and in real estate over the next 24 to 36 months, just as there was post 2009. For builders, people do not want 1950 type houses. That is what drove the early 2000s boom, which is why real estate has weathered essentially every recession. Location, quality, and patience. Deep pockets to weather short storms do not hurt. Why am I so confident that opportunity is knocking? Because rates are NEVER going up. What is going on right now you may ask? First, 5-7% is not up. Second, it took the bond market exactly 8.2 seconds to invert the curve and start driving rates down. If a higher rate environment cannot survive multiple years, it is not higher rates. Jerome Powell and the Fed are just hanging on for dear life because they know what is next.
And how do I believe this with every fiber of my capital markets experience? If you cannot safely land that ship, what do you do? You crash it and then print more money and we rinse and repeat. It is coming like a freight train, get ready. It is going to be great for those who are.
