Updated: Jan 10
Recession or not?
Canada has tripped 4 Bank of International Settlements (BIS) Early Warning Indicators for Credit Risk (EWI). EWIs can be quantitative or qualitative indicators based on asset quality, capital, liquidity, profitability, market, and macroeconomic metrics. The EWIs that were tripped so far include:
Residential Property (RP). Three times before Canada crossed the RP threshold: the 2008 crisis. The subsequent recession. But the third time, the threshold was overwhelmed by the pandemic.
Total Private-Sector Debt Service
Household Debt Service
The BIS estimates that when thresholds are crossed, they elevate the probability of a systemic banking crisis to 50 percent in the next 12 quarters. The average post-WW2 chance a country experiences a financial crisis in any year runs at 7 percent. The likelihood of Canada facing a systemic banking crisis and a recession is running much higher than average now that we have crossed not one but four thresholds.
Spending alone with the most recent positive GDP report will not be enough. Proponents of no recession will likely lean heavily on the idea that the Canadian economy grew in the latest period measured (Oct), just as it did in the previous month. They will likely concede that it was not by much – only 1.2% annualized. But, the argument will be that growth is growth. They may also note that in 2022, as we come to the year’s end, there have been no negative numbers. No quarter of contraction, let alone the two required to define a downturn—they conclude that there will be no recession.
But as I stated this year publicly on our Hard Money podcast (approximately 2 minutes and 40 seconds in), this recession will look different. Back in the good old days, recessions were simply the unpleasant part of the business cycle. Consumer choices, exuberant businesses, and monetary policy would periodically generate growth contractions. We debated the timing, but recessions didn’t come out of the blue.
Then in 2020, a recession did come out of the blue, or nearly so, when COVID unexpectedly changed behaviour. Working from home, avoiding travel, etc., caused a sudden drop in service demand and, thus, a recession. This wasn’t part of the business cycle.
The last “normal” recession ended in or around 2010/2011, about 11 years ago. As with most unpleasant experiences, we don’t put a lot of energy into remembering what it was like, especially here in Canada, since we felt less affected.
Remember, though, this will be a strange recession, in my honest opinion. This coming recession will not be like the others we have experienced for a long time. It doesn’t have the usual causes and may not have the typical effects.
Let’s start with employment. The total number of nonfarm jobs increased steadily until the brief COVID recession, fell hard, and as of the 2nd quarter, fully recovered and grew some. It has been making good headway. This is not, however, to suggest the quality of jobs is better or the same. In my opinion, it is worse overall as we look around and into communities of businesses needing to hire functional, flexible, non-career staff to be able to turn on a dime. Are people getting better than minimum wage? Yes, they are.
However, the number of positions available to career individuals has slowed dramatically as businesses are not yet comfortable taking on long-term risks.
A longer-term look at this same data series shows employment tends to peak just as recessions begin, which could be in 2023. The most recent two months of job data show massive layoffs in the tech sector. (Amazon, Twitter, BuzzFeed, Properly, TealBook, D2L, Symend etc.) Here and down south, as well as what appears to be a contagion effect now spreading into banking (Wells Fargo, Bank of American), media (Bell, Global, CNN, Disney, Discovery, Washington Post), and other centres of the economy. But note that since 1994 every pre-recession peak was higher than the last pre-recession peak. If the same doesn’t happen this time, we’ll have yet another reason to call this recession “strange.”
Regrettably, I think that consequence is probable. Today’s higher energy prices and war-related disturbances have begun to bite us in the proverbial arse. Many businesses desperate to hire earlier this year have witnessed slower sales and have stopped adding staff. That’s the first step to reducing staff. In addition, I note the significant drop in media-posted stories of businesses trying to find sufficient numbers of staff or finding it nearly impossible to fully staff. This is not perfect. A percentage of the business base is still seeking better employment options. After employment, there is income.
From a purely statistical picture, you can argue that wages have risen. Scotiabank even reported that wages were ahead of inflation just a week ago. This means salaries are increasing at 7% versus the posted rate of 6.8% inflation. But any average person knows this is not the case. This stat does not consider underpaid employees and the relative relationship to career positions versus contract or part-time. The picture is not at all what it appears to be. Have you, the reader, had a 7% increase in your wages this year?
We pooled our reader base, and 92% of you responded (Over 500 replies) that you had not had a 7% increase. No alarm bells are ringing there. And if you have had a 7% increase and were making the average income, congratulations, but it still isn’t enough to be the higher bills, food, and consumer goods that have inflated out of control. It is estimated that in Canada, new home buyers will use almost 2/3 of their monthly income to support house-related costs. This is not a situation that can last. The bulk of wage increases are not meeting the demands of inflation, and as long as we stay this way with the costs of daily consumables rising as much as they have, we will arrive at a far less desirable outcome of stagflation.
A recession can be inflationary when accompanied by a supply shock in essential goods. Then you simultaneously get falling growth and rising prices—an especially miserable combination. We call this stagflation: stagnation + inflation, which last occurred in the 1970s. And for similar reasons: higher energy prices, higher cost of housing, and higher cost of consumables.
The macro effects of all this take time. At first, people grumble. But eventually, they start changing their behaviour. They stop taking the boat out on weekends, don’t drive to the beach as often, and look for jobs closer to home. Maybe they try to sell the giant SUV and find it’s not worth as much as they thought. This affects their confidence, so they reduce other spending. And because inflation is higher than their wage increases, they feel even more pressure. This is the tail end of the spending period. I do not expect to see more GDP growth, at least not any meaningful growth.
I suspect that the magnitude of consumer and government debt will more than crush us. When we owe enough, creditors will line up to take something from us. Natural resources, consumables, and real estate will all be on the table now. Having a $10,000 buyer’s premium on real estate or any other tax does very little to deter those who have sufficient funds from buying residential real estate, which otherwise might have less competition to buy and might be cheaper for a Canadian buyer. But I digress.
The International Monetary Fund now projects that global GDP growth will slow from 6% in 2021 to 3.2% in 2022 and 2.7% in 2023. The Fund characterized this as “the weakest growth profile since 2001, except for the global financial crisis and the onset of the Covid-19 pandemic.”
Meanwhile, global inflation is forecast to rise from 4.7% in 2021 to 8.8% this year before declining to 6.5% in 2023 and to 4.1% by 2024, remaining above the target levels for many major central banks.
I am not suggesting that this will be 2008 all over again. But I am pragmatic, and I do not like what lies ahead. I do not think wages will grow much, except in the major arenas where there is competition for high-end employees. As I have mentioned in the last six months, I suspect stagflation will be the prevalent landing spot, and it will be hard to avoid.
As for silver and gold, there is no evidence suggesting both metals will end up in positive territory yet again for 2023, and neither has the impetus to achieve new highs in 2023. That would take gold beyond the $2040 mark, while silver would have a way to climb to get back above $52, its all-time high.
If you have patience, smarts, a need to balance your wealth, lighten the load from the traditional paper assets, and more patience, then I suspect you will enjoy the story of silver and gold. No matter what mainstream donut talks about either metal in a negative light, there is a reason why the major central banks are net BUYERS right now and have been since the end of 2009. They fear what lies ahead, even if it is not a perfect timeline. They know the pain the average person will suffer and need assets that will protect their investments beyond the USD. Here is the warning shot.
Yours to the penny,
Darren V. Long
Delta Harbour Assets.