To The Moon

Key Takeaways:

1. Under High CPI and Many Exogenous Events, Reccession is Possible.

2. How to identify a reccession when it happens?

In recent weeks, the market is worried that the global economy will enter a stagflation (GDP Down while CPI Rise). Because of the pandemic still exists, regional economy becoming more tense than before,  the conflict between Russia and Ukraine triggered stock market decline.

Source From Economic and Financial's research platform Calculate Risk, The response to inflation can be seen from U.S. Retail Sales, Housing Starts, Industrial Production which showed as below:

This graph shows retail sales since 1992. This is monthly retail sales and food service, seasonally adjusted (total and ex-gasoline). Retail sales ex-gasoline were up 4.2% in January.

This graph shows single and multi-family housing starts since 1968.The consensus is for 1.695 million SAAR, up from 1.638 million SAAR.This graph shows industrial production since 1967.The consensus is for a 0.5% increase in Industrial Production, and for Capacity Utilization to increase to 77.9%.

1. Under High CPI and Many Exogenous Events, Reccession is Possible.

The factors that trigger Recession may includes:An exogenous event such as a pandemic, significant military conflict, disruption of energy supplies for any reason, a major natural disaster (meteor strike, super volcano, etc), policy errors,and a number of other low probability reasons.

In 2020,pandemic happened globally till now; We've seen several policy errors over the last several years, mostly related to immigration and trade;  while the current concern With inflation picking up due to the pandemic (stimulus spending, supply constraints) and the conflict between Russia and Ukraine, The Fed will embark this week on a tightening cycle to slow inflation.

Most of the post-WWII recessions were caused by the Fed tightening monetary policy to slow inflation. I think this is the most likely cause of the next recession. Usually, when inflation starts to become a concern, the Fed tries to engineer a "soft landing", and frequently the result is a recession.

As The Fed cannot ease pandemic related supply constraints (except by curbing demand), and the Fed cannot stop the war. So, there is a possibility that the Fed will tighten too much and that will lead to a "hard landing" (aka recession).

2. How to identify a reccession when it happens?

One model for business cycle forecasting uses new home sales (also housing starts and residential investment).

For the economy, We can focus on is single family starts and new home sales.

For the bottoms and troughs for key housing activity, here is a graph of Single family housing starts, New Home Sales, and Residential Investment (RI) as a percent of GDP.

The purpose of this graph is to show that these three indicators generally reach peaks and troughs together. Note that Residential Investment is quarterly and single-family starts and new home sales are monthly.

The New Home Sales data is smoothed using athree month centered averagebefore calculating the YoY change. The Census Bureau data starts in 1963.

When the YoY change in New Home Sales falls about 20%, usually a recession will follow.Anotherexception was the recent situation- we saw a YoY decline in new home sales related to the pandemic and the surge in new home sales in the second half of 2020.

Conclusion:

If the Fed tightening cycle will lead to a recession, we should see housing turn down first (new home sales, single family starts, residential investment).