Economic contraction steepens as central bank tightening slows down the economic wheels.
Economic activity is now decelerating into the contractionary phase of the economic cycle.
The Federal Reserve’s 150 basis points rate hike since 2022 has smothered the inflation fire. July’s US CPI of 8.5% could have peaked.
We expect to see late summer sales for discretionary items like never before, which is beginning to play out.
Necessities, food, energy, and shelter expenses remain near decade highs, which reduces household disposable income for non-discretionary items.
Contract and subscriptions are where most of the cutback is likely to be, 66% according to a recent Statista survey here.
“Economic activity is now decelerating into the contractionary phase of the economic cycle”
The economic contraction does not bode well for the likes of Netflix or clothes 42%, bars restaurants 39%, and travel vacations, where 38% of respondents said they would cut back
The sector where American consumers would least cut back in an economic contraction is Insurance at 8%, education at 12%, interior decoration and appliances at 23%, and beauty at 25%.
Surprisingly, more Americans would cut back on food or household goods in an economic contraction 35%, than hobbies, where only 30% of respondents said they would cut back on expenses.
Here is the takeaway; the economic contraction will likely hit brands in foods and clothing where demand is the most price elastic
The economic contraction, engineered by Fed rate hikes, is already impacting the real estate market as borrowing applications for mortgages collapse. The housing bubble and real estate crash are ripe to play out. A string of data is pointing to a housing downturn.
The oversupply of new houses for sale, with over 9 months of supply in total at all stages of construction, is a red flag, according to the Census Bureau.
“the economic contraction will likely hit brands in foods and clothing where demand is the most price elastic”
In June, 463,000 new single-family houses were for sale, the highest since May 2008 and up by over 30% from a year ago.
Homebuilders’ cancellation rates spiked to nearly 18% of their total signed contracts in July, more than double from earlier this year and last year, according to data from real estate consulting firm, John Burns.
So, this cancellation rate was even worse than the cancellation rate in April 2020, during the lockdowns.
The Census Bureau reported that sales of new single-family houses have plunged 17% from a year ago, and are barely above the lockdown low of April 2020.
The economic contraction is flagging a mismatch in the real estate market in what sellers are asking and what buyers are willing and able to pay.
So, the real estate crash could be on par with 2008, bearing in mind that real estate is a highly leveraged asset financed with borrowings.
Commercial real estate is where we see the most price adjustments and deleverage occuring in the coming real estate correction, bearing in mind lending to households was laxer in 2008 than in the 2020s.
Moreover, spiraling energy costs and wages that do not keep up with inflation have made working from home whenever possible the preferred option for workers.
The economic contraction is likely to impact commercial real estate the most. The opportunity for investors could be in buying deep discounted commercial real estate and converting it into residential properties.
“Lockdowns have shown that citizens can be bought, and democracy is cheap. Populations will surrender their freedom and go along with whatever charade if their necessities are provided” – Win Investing
Economic contraction was highlighted in July when US GDP fell in the second quarter, which was the second quarter decline in GDP
The definition of a recession is two consecutive quarters of contracting GDP. So the economic cycle is in the contractionary stage of a recession.
Where we are in the central bank liquidity cycle will determine the severity of the 2022 recession, which could result in a depression if central banks continue with aggressive tightening in an economic contraction.
Peak inflation is an indication of peak tightening.
In other words, when the Fed realizes monetary tightening has broken the economy when they no longer worry about a hot economy and runaway inflation and start worrying about demand destruction, hungry and cold households, that is typically when the Fed pivots.
The political fallout from tightening becomes too risky. No society is more than three meals from a revolution.
Lockdowns have shown that citizens can be bought, and democracy is cheap. Populations will surrender their freedom and go along with whatever charade if their necessities are provided.
Moreover, when investors’ losses are so great that markets become uninvestable the Fed typically pivots.
The first half of 2022 was the worse half in four decades, as the bubble of everything popped.
The recent relief rally could indicate that the investor psychology cycle has reached a trough and is coming out of a depression.
“fortune favors the brave, and an economic contraction could be a prudent time to plant seeds when prices are depressed. Then harvest the profits in the boom” – Win Investing
So the crux of the economic contraction is that the best discounts for investors are found when the investor psychology cycle is coming out of a depression, the economic cycle is in contraction, and when central bank tightening has troughed and is moving towards normalizing and easing.
In other words, investors make most of their money buying beaten quality assets, and technology riding the long wave of innovation in the depression and realizing those profits in a boom.
Fortune favors the brave, and an economic contraction could be a prudent time to plant seeds when prices are depressed. Then harvest the profits in the boom.
Conservative money and pension funds are likely to rotate into large capitalised stocks, companies that make products needed and pay good dividends.
Central banks will buy the debt, which nobody wants to hold.
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