Editor’s Note: Dennis Fassett is a former corporate finance executive turned real estate investing “Cash Flow Mercenary.” Dennis specializes in single-family and multi-family cash flow properties and thoroughly enjoys assisting his fellow investors with their own strategies, including how to buy your first apartment building.
As an ongoing contributor to Mogul’s “Market News Updates,” Mr. Fassett provides us with his own unique, lively, and thought-provoking commentary on the timely industry news and events of today that are impacting our industry. And be sure to check out his other super-helpful Market News Updates. For now, enjoy...
From Dennis Fassett, Cash Flow Mercenary...
There are two kinds of real estate investors in this world. The kind that keeps up with economic data, and the kind that ignores them and ends up as REI roadkill.
If you’re in the second group, then you should immediately move on to watching more cat videos on Facebook. See, I’m going to discuss a lot of yucky stats and economic data that I guarantee you don’t have any interest in reading.
If you’re in the first group, however, this stuff should make you sit up and take notice. And then act. It did for me.
I read an article that made the point that, as the title says, the next recession is already upon us. And while you can find countless pundits and talking heads forecasting a “hockey stick” recovery for the economy, they’re missing the point that the U.S. most likely entered into a recession at the end of last quarter.
The piece stated that (here comes the first yucky stat) after adjusting nominal GDP growth for core consumer price inflation for the average of the past two quarters, the recession is already here.
To make their point, the article looked at five critical economic indicators that both individually and together illustrate that the economy has been steadily deteriorating for the past few years and that the pace of decline has recently picked up steam.
The 5 Indicators:
#1. The Price of Copper
There is no better indicator of global growth than copper, because it has traditionally been a great barometer of economic health. Unfortunately, copper has been in a bear market for the past five years and shows no sign of a recovery from its 55% plunge.
#2. The Baltic Dry Index
This index measures the demand to transport dry commodities overseas. An increase of this index would represent an increase in global growth. But this index has been in a downtrend since the end of 2013 and fallen 75% from that point.
#3. Spread Between 2- and 10-year Treasury Notes
There is little debate that the worldwide economy is stagnating, and despite what some would like to argue, the United States has not been immune from this slowdown at all.
Look at the spread between the two and 10-year Treasury notes. When this spread is getting more narrow, there is increased pressure on banks' profits, which leads to falling loan growth and less economic activity. The spread has been narrowing since July 2015 and is now the tightest since November 2007.
Remember what was happening then?
#4. Industrial Production
This measures the output of factories, mines and utilities in the U.S. economy. The Wall Street Journal recently wrote even more yucky stats about this indicator:
"Overall industrial production peaked in November 2014 but has failed to regain that level amid a mining sector collapse and leveling off at factories. Overall industrial production was down 1.4 percent in the 12 months through May. Utility output is down 0.8 percent and mining output has plunged 11.5 percent."
#5. Non-Farm Payrolls
The lagging economic indicator known as the non-farm payrolls report is also falling fast. Last month's disappointing 38k net new jobs created was written off as an anomaly, but the data shows that this was actually part of a declining trend that has been in place since October 2015.
The article concluded from all this that:
“The falling copper price, tumbling global trade, a flattening yield curve, weakening industrial production and the declining monthly job creation all point to an economy headed into contraction.”
Final Yucky Stats
To confirm all of this, the author looked at data published by the Bureau of Economic Analysis (BEA) and the Bureau of Labor Statistics (BLS).
The definition of recession is two consecutive quarters of negative GDP growth. During Q4 2015 and Q1 2016, real GDP posted 1.4% and 0.8 % growth, so officially we're not in one – yet.
However, when deflating nominal GDP by the core rate of Consumer Price Inflation, you get real GDP of just 0.3% in Q4, and negative 0.8% during Q1.
Therefore, the economy is dangerously close to a contractionary phase – and is already in one when averaging the prior two quarters (at minus 0.25% when adjusted by core inflation).
And Now the Bad News
To wrap up the analysis, the author took a look back at the last recession, which is still burned into the brains of the real estate investors who adapted and withered the storm.
He said that it took 1.5 years to bring the economy out of the Great Recession that began in December 2007. And it took a $3.7 trillion increase in the Federal Reserve's balance sheet, plus 5.25% interest-rates cuts to pull us out.
The problem? Guess what? The Fed already has a bloated balance sheet in relation to GDP and only a few interest rate percent points available to reduce borrowing costs before short-term rates hit 0%. Therefore, there just isn't much the Fed can do this time around.
Which means this next recession could be deeper and last even longer than the previous one.
Don’t think The Baltic Dry Index has anything to do with real estate in your market? Think again.
Prudent investors should hedge their portfolios now from such an unwelcome event. I’ve already started.
What’s Your Take?
We headed into a recession? We already in one? I wanna hear your thoughts.