Well, let’s just say the next recession is smoking right outside your window. You’re lying in your bed at night. You can’t see the intruder, and you don’t think he’s in the house yet, but you know he’s there because you can smell his cigarette smoke through your bedroom window.
That’s where we are right now. Fourth quarter GDP for 2021 is trying to make a fool out of me by coming in with a stellar glow at 6.9% growth, which MSN referred to it as “the fastest full-year clip since 1984, despite ongoing pandemic.”
You may recall I made the following brazen prediction last October:
Prediction: What few of the gurus are telling you, which I will, is that we’ll be in a recession by sometime this winter.
Of course, we had less than two weeks of winter during the quarter for which GDP was just reported. So, most of winter is still before us.
However, I also said,
In fact, I think Q4 growth will prove to have been negative when we see the numbers in print next year. If not, then very close.
The 4th quarters leap upward certainly doesn’t look good for my prediction, and it doesn’t appear to fit at all with what I thought we’d see by the close of the fourth quarter, though I clearly delineated that second statement was not part of my prediction, but the statement does indicate how close I thought we’d be to recession by the end of the fourth quarter. So, this GDP report looks like everything ran away from me.
But did it? Did I screw up?
As I promised when this report that runs in the opposite direction of my prediction came out, I’d have to look under the hood to see what was going on. On first blush, the headline number looked fantastic, and you may decide that I was dead wrong about sliding into a recession in the winter of 2022, but please hear me out first; there is a strong argument to be made that this report is a phantom. If you look behind its gossamer veil, you see only dead men’s bones.
Let’s do that.
First, though, let me acknowledge GDP even barreled over the top of economists’ expectations, which averaged around 5.5%. So, it’s a big jump to our best quarter in over a year. Back when I made my recession prediction, third-quarter GDP certainly fell like we were heading into recession, though my prediction was based on much more than the downturn in the path of GDP. My article laid out that it was based on my early claim that people were not returning to work and would not be returning, which meant shortages that were still building would keep building, which would keep fueling inflation to the point of stagflation. That whole daisy chain of reasoning went as I expected, so why did GDP run the other way?
The shortages were key to the recession I foresaw coming, and I urged people to prepare for them:
I foresee a winter at some times and places where you’ll feel for the first time in American life like you have slid down the rabbit hole and ended in a version of the USA that looks and feels more upside-down than the old USSR where stores have a lot of empty shelves, and complaining can do nothing to fill them.
Well, Zero Hedge peaked under the hood of this GDP report, and the first thing they noted was…
The components of GDP are an ominous confirmation that the US is engaging in aggressive restocking which could soon lead to a deflationary liquidation wave. According to the BEA, the acceleration in the fourth quarter was led by an upturn in exports as well as accelerations in inventory investment and consumer spending.
I don’t know about a deflationary wave just yet, but recessions are usually (though not always) deflationary. I, however, was arguing for a stagflationary recession — meaning the very rare and most devastating kind where inflation keeps rising even as the economy crashes. Rising prices make the recession twice as hard to bear. The restocking ZH mentions is the first place my mind went when I saw the headline number, too. I thought, Maybe widespread concerns about exactly the scene I said I could foresee coming became something many foresaw coming, causing them to pull buying forward, forcing stores to rapidly restock.
GDP that is created from today’s aggressive stocking-up speaks of a one-off fear factor driving GDP up, which will do the reverse in the next quarter. Businesses already seeing shortages put in as much stock as they could possibly get their hands on and find room for, according to this GDP report. In that case, last quarter’s boost to GDP from stocking up will be this quarter’s drop in GDP as businesses sell through the stock they already put in, buying less in Q1-2022, making this rise in GDP a very weak basis, likely to fade, for thinking GDP proves the economy is strong as many have been claiming. I have been decidedly in the minority for claiming the opposite, but I’m used to that, cold and uncomfortable as it is.
I know my wife and I bought literally twice as much of everything we regularly buy that had a long shelf life, and I know I counseled all my readers to lay in whatever they could in the fourth quarter of 2021 so they would be ready for the possible shortages of 2022. However, a look at the major categories of GDP surprised me:
To some extent consumers did stock up (purple bar more than doubling in size), but most of the growth in GDP was in private business inventories. Personal consumption was up 2.5% but that was from a level of spending that was minuscule the quarter before, while growth in inventories more than doubled from an already larger portion of GDP, accounting for 70% of the total GDP growth number last quarter. Consumers may have been slower to get the picture of what was coming than businesses who didn’t want to get caught out in the cold.
Exports were the second largest contributing category, but an exactly equal level of imports washed that out. (Exports get added to GDP; imports, subtracted.) So, really, this was all about retail stocking warehouses, and to a lesser extent consumers stocking up home inventories in anticipation of shortages to come.
Last quarter’s stocking is likely to reduce this quarter’s buying. Since GDP growth in this report lies almost entirely in inventory builds and consumer retail, there is a strong likelihood the entire GDP jump was driven by shortage scares to where everyone’s prepping last quarter will result in a slump this quarter. I’ll show evidence below that both businesses and consumers pulled a lot of buying forward.
(These numbers, by the way, are real GDP, so they factor in inflation. That is important because GDP is reported in dollars, not units of items sold, so growth is not growth at all, except to the point it exceeds the deflation in the value of the dollar used to measure GDP (usually measured and spoken of as inflation in prices). At first, I wondered if price inflation (dollar deflation in value) was why I was off about the economy skidding into recession at the end of 2021, but that wasn’t it. Real GDP was what reports were talking about.)
Here, you can see how big the boost was from inventory stocking:
Add to that the jump in consumer retail, which was likely consumers stocking up. The only quarter in, at least, the last two decades that beats this one for stocking up was the massive restocking that occurred right after the national COVID lockdown in 2020 when businesses rushed to stock up to recover from hoarding and from the fact that suppliers had been closed down for more than a month. So, it really does turn out that stocking up was the big story of what fourth quarter GDP growth was all about in 2021. Says ZH,
In other words, the inventory restocking process is now running red hot – even if many won’t notice it on the shelves of their favorite retailer – and in future quarters will likely lead to further declines in GDP,
That means the Fed will be, as I’ve said, hiking into a recession, but the Fed doesn’t seem to know that.
I won’t rest my case just on this look under the hood at what the numbers were about, but let’s take a look at whether last quarter’s growth was quite the big deal being made out of it.
On a year-on-year basis, versus the annualized quarterly basis reported, real GDP rose 5.7% (annualized being how much GDP would be one year ahead if this quarter’s growth continued through each of the next three quarters). So, the real, real number, versus the annualized one is not quite as high but still strong on the surface. (The annualized one isn’t going to materialize because, as you will see below, this quarter is already looking far worse, not the same.) Again, ZH sees it the same way:
Peeking between the lines reveals that it was a very low quality print, one driven almost entirely by a surge in inventories…. It’s all downhill from here, with sellside expectations for Q1 2022 looking much more ominous….
As big as that spurt due solely to prepping for hard times was, you can see it still did not restore the economy back to the trend it was on before COVID closures:
Plus, as I say, GDP growth is not going to annualize at that rate or anything near that as the rest of the quarters of the year come in, but I won’t leave you to rely on me alone for that prediction.
Even MSN notes,
Earlier in 2021, economists worried that global supply chain problems would keep businesses from being able to fully stock shelves. But a rush by companies in the final months of 2021 to bolster their inventories ultimately drove gross domestic product much higher.
All of this means it is actually a sign that consumers and businesses believe we are going into those recessionary times of serious shortages I described. Companies did all they could, MSN says, to “mitigate supply chain risk.”
But the 2022 economy will have much less support behind it, as the Fed raises interest rates and Congress appears to have little appetite for more covid-related stimulus.
Many others are starting to agree with my recession prediction for winter 2022
This is where we come down to inflation smoking right outside your bedroom window.
Summarizing the changes in predictions for the economy that are flying in, Zero Hedge stated,
US GDP growth is now rapidly collapsing and may turn negative as soon as this or next quarter as the US economy contracts for the first time since the covid shutdowns in Q1/Q2 2020.
No sooner had that hot-on-the-surface GDP print come screaming through, than JPMorgan revised its future predictions for GDP down, unmoved by the loud report, writing that its Economic Activity Surprise Index…
has swung sharply into negative territory in recent weeks, indicating data have underperformed relative to consensus expectations.
That hardly supports a view that the uprising in GDP is putting in a new growth trend after what was sharply falling GDP growth in the quarter before — so sharp it looked like it would hit my target of recession putting in its first negative as early as the end of the fourth quarter. JPMorgan’s data reinforce my opinion (and ZH‘s) that the burst in GDP growth in the final quarter really was only about stocking up as quickly as possible in the face of shortages.
JPM explains that their index “indicates consumption should moderate in 1Q22.” Since consumption is 70% of the US economy, guess where that takes GDP growth? Well, JPM says it will take it from the robust near 7% print down to 1.5% this quarter.
Oh, but wait! They turn out to be the optimists in the crowd. Wait until you see where others take it. And, says ZH, about the basis for believing in a big downturn right now:
It’s not just retail sales, however, or that recent Empire Fed Manufacturing Survey, which just suffered its 3rd biggest monthly drop in history (with only March and April 2020 worse)…
It’s also a new rise in jobless claims:
Even the White House is now forewarning us that the final report for January on jobs is going to be MUCH WORSE. Now that may be due to a “transitory” rise in sick leave because of Omicron, as the White House claims in readying our nerves for what we’re about to see, except how many people who go out sick file for unemployment benefits when most have sick-leave benefits and when you have to wait a week to become eligible for unemployment anyway? Could the White House be using COVID to cover for the further devastation brought out by its vaccine mandates and their state-level copycats that did survive? Still, COVID sickness COULD be all this rise in unemployment is.
Bank of America notes that consumers are feeling the pinch. The fact that they are buying on credit now, not savings, indicates they have used up the savings laid in from all the stimulus checks, which was the big basis for many claims that the economy will keep roaring in 2022:
BofA offers this warning:
When stocks, credit & housing markets have been conditioned for indefinite continuation of “Lowest Rates in 5000 Years” [it] might only take a couple of rate hikes to cause an event….
An event like a recession?
“Rates shock” is grounds for an imminent “recession fear.”
Which is why Bank of America just stunned America by slashing its growth rate even lower than JPMorgan’s in what now looks like a race to the bottom — down to 1.0% for the present quarter. Bear in mind, though, both of these banks have shown a tendency to be bullish in their GDP estimates and to feel the need to revise down as the quarter wanes.
To my own point, BofA also saw the same thing in the GDP data for the fourth quarter of 2021 that I saw:
It is important to remember that GDP depends on the change in inventories (not the level), and GDP growth depends on the change in the change in inventories. Therefore the $173.5bn increase in inventories in 4Q limits the scope for inventories to drive growth again in 1Q.
So, as I said, count that major contributor to GDP growth in the last quarter as a one-off.
“OK,” you say, “but those who are coming alongside what you predicted clear back in October for the present when no one else was predicting a recession this winter are still not predicting numbers that are quite a recession!”
Oh, but it gets worse!
Goldman Sachs just cut their GDP forecast for this quarter from 2.0% all the way down to 0.5%! They gave the following explanation.
Growth is likely to slow abruptly in 2022, as fiscal support fades and, in the near-term, virus spread weighs on services spending and prolongs supply chain disruption.
They noted a “sharp deceleration in growth from 2021 into 2022″ as being likely.
Goldman calculates that fiscal support boosted real disposable income to 5% above the pre-pandemic trend on average in 2021, but following the lapse of the expanded child tax credit this month, disposable income has likely dipped below trend and will remain an average of 1% below the pre-pandemic trend in 2022—even after penciling in strong gains in labor income. As Goldman’s Jan Hatzius writes, “this decline should weigh on consumer spending—and is a large part of why we expect growth to slow….“
And note this part:
According to Goldman’s estimate, Q1 will see +$65bn (annualized) in inventory growth (vs. +$173bn in Q4), which would subtract 2% from Q1 GDP growth.… It “lowered our Q1 GDP forecast by 1.5pp to +0.5% (qoq)—mainly reflecting our expectation for a large negative contribution from the inventories component of GDP.”
“OK, but hold on!” you say. “0.5% growth may be really, really close to sinking into recession, but it is still not negative (recessionary) growth!”
All right, I got it.
But it gets worse!
The Fed even now agrees with me that the economy is sliding, in the very least, right up to the very, very edge of the abyss.
The Atlanta Fed, which runs what the Fed calls its “GDP Now” estimation of how the current quarter’s GDP will turn out, posts the following: (The green dot being the Fed’s estimate.)
That’s right. The Fed pegs this winter quarter’s GDP growth at 0.1%. Now that is as close as their margin of error gets to tipping into recession without actually being in recession.
OK, I hear it coming: “But 0.1% is still not recessionary.”
Fair enough, but did you happen to notice how everyone is now rushing to get to where I said four months ago we’d be this winter? Do, you think maybe the momentum all these forecasters have in downshifting their own forecasts to get to where mine went four months ago might just carry them in another week or two the remaining tiny distance to my position?
The yield-curve curve ball
“But there are better predictors,” you say. “Everyone knows the REAL predictor of a recession is when the yield curve inverts. Even the Fed says that is their MOST reliable indicator!”
Inversion doesn’t get any closer than that! Give it until tomorrow!
“Oh, but…” you say, “the yield curve usually inverts six months to a year before the economy goes into recession. Just look at that same graph for the last three recessions.”
True, but remember our thesis? Since the last recession, the Fed has been in absolute control of the yield curve for the past two years because it is the fat whale that occupied more than 50% of the treasury bond pool. Now that the Fed is exiting the pool, the yield curve is repricing faster, I believe, than anytime in history. And the Fed is only halfway out of the pool!
Why is the yield curve repricing so rapidly? Because bonds are regaining true price discovery as the Fed steps away from controlling the market. Bonds are just now being allowed to price in what they WOULD HAVE PRICED IN LAST SUMMER, had they had any ability to price in anything last summer, but they did not because the Fed controlled pricing and is only now letting go of the reins and giving the market its head.
So, watch bonds rip through that yield curve inversion as the vigilantes take over! They are only a nose hair from the finish line already, and consider that they are doing their best to price in yesteryear’s yield curve.
“I need more proof,” you say.
Get outa here!
Reprinted with author’s permission from The Great Recession Blog