Did We Dodge a Recession? With Warren Pies

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1:24And now to the top analysis of today's markets.

1:34Did the U.S. dodge a recession? Hi, everyone. Welcome to the Real Vision Daily Briefing. With me today is Warren Pies, co-founder of 314 Research. Hi, Warren. It's great to see you. Good to be back. Thanks for having me. So we kicked off the week for a lot of people. It was a long weekend here in the U.S. anyway, with a federal holiday. And so we're in a trading shortened week. And everybody came back and we saw sort of stocks slide, give up some of those gains, although they did come off the lows of the day, helped maybe in part by home builders who did outperform after we had a stronger than expected housing report.

2:11I know that you've been looking into housing a lot too. So what'd you make of the number? What do we need to understand about what's happening in housing? Well, this is to me, we're laser focused on housing right now, because to me, the most important question across assets is recession timing. Like, are we going to have a recession? And if so, when is that going to hit? And so in our view at 314, we've kind of created a little model of the U.S. housing market. And when you go back into history, just to give you the quick background, you go back into history, in general, you see residential construction payrolls fall by 8 % to 10 % right before you get into a recession in the United States.

2:55So that's what we're looking for is a drawdown of 8 % to 10 % in residential construction payrolls. And really, when you think about what drives payrolls, it's the number of units under construction. And when you back out from there, what drives units under construction, it's the number of houses that are started and then how long it takes to finish a house. And so those are the real moving parts. I mean, you can break the industry up into single family homes and multifamily homes. There's about three times as many workers for each single family unit over multifamily unit, but we model all this out because we're trying to find that eight to 10 % decline in residential construction payrolls and when it hits.

3:32And so it's really important for us to track starts as a part of that. And today we got that all important new housing starts number and it came in at, we were looking, it's been at like a 70 ,000 on a single family starts have been coming in about 70 ,000 new units per month. We were expecting in order to get to our recession timeline, which is Q1 of next year, we at 314 were expecting single family starts to fall to like 60 ,000 units per month. And today you got a crazy rebound to like 83 ,000 units in the month of May. So you're way off of the trajectory that you need to be to get to a recession.

4:17So that's single family. Multifamily is less economically sensitive, but still drives a big part of that residential construction employment. And we've seen a divergence in the economics of multifamily and single family over the course of this pandemic. So multifamily is not as shocking, but it still went from like 45 ,000 units a month to 52 ,000 units in May. So on single family and multifamily today was just a head scratcher. If you're a recession watcher and you're an economic kind of timer, which is obviously a big part of macro investing. So that to me was the big news of the day. That's so interesting.

4:57What do you think is driving that strength? Why are we seeing a rebound? Well, there are a few theories. I think the number one theory is just very supply constrained. And so the whole golden handcuffs concept, the idea that mortgage rates have gone up so much and that anyone who has a 3 % mortgage and just can think through common sense is not selling your house. So existing home supply is very low, which puts all the impetus back on the builders and on new construction. And so that to me is the most likely culprit. When you dig into the geographic areas where we're seeing new starts, it's not the Northeast.

5:39You're seeing Midwest is kind of going crazy in this last report comparatively to other regions. So there's an idea that, you know, I'm just playing with ideas that this new remote work trend is allowing people to migrate out of these urban centers and into more affordable regions of the country, which would be, you know, Midwest is in there. So that's, I think, part of it as well. But at the end of the day, the real straw that stirs the drink is affordability. And affordability has gone from, you know,$2 ,000 in real terms has been an area where we've seen housing activity slow consistently over the course of history.

6:22We went from, you know,$1 ,600 a month for housing payments, before the pandemic to 3 ,000, almost a doubling in your monthly home payment on average in the United States. And so to me, that should slow activity no matter what, even if we're talking about golden handcuffs or whatever, it's just at some point you can't make the math work. Now, the other thing that I didn't mention, but it's the last part that's kind of allowing, I think, some of these new buyers to come into the market is builder buy-down. So builders are buying down the interest rates. A lot of times that's temporary for new home sales and allowing the math to work.

7:04But all of these things have a limited runway that they can work. So I think this is just an important, it's one data point, you'll want to overreact. But if we stay on this trajectory, I mean, recession, in my view, at 70 ,000 new single family starts every month, you have a recession landing somewhere in the back half of 2024. If you go up to 80 ,000 a month, which is where we're at this report for the month of May, I just don't see a recession. That's not a contractionary number in my view. Wow, which is incredible. And I think you really underscored why it's been very difficult. I mean, this is the most talked about recession.

7:41We say this all the time. And it's been such a moving target. By the way, those builder incentives you mentioned, both Brian and Melody commenting about that on the platform chat as well as one component. But as you say, it's sort of a mix of everything. I just want to back up for a second, though, because I think that this is something that's really important and doesn't get talked about a lot. We talk about housing and supply, the supply of new homes, trying to meet that and the undersupply that existed. It's very interesting to me that you're really focused on residential construction payrolls.

8:17roles. So it's sort of what's happening, not so much with the supply of homes, but what's happening with the workforce that you see as really critical here. That's so interesting to me that we don't hear that all the time. Yeah. I mean, you're always looking for a leading indicator. The whole, the recession is basically, if you can boil it down, you need to see job losses if we're going into recession. So we had a chart in our last report. I probably should have passed along, but I can describe it really quickly. It's just we lined up aggregate payroll growth at the beginning of every recession.

8:52And we've just chugged higher here. Like for the people who think we're already in a recession, this chart kind of disproves that notion immediately. So you just see payrolls chugging higher. Every single other recession is marked by job losses. That's what we're talking about. You can talk about PMIs and, you know, leading economic indicators and all these indices and financial conditions. You can get into a lot of different rabbit holes here. But the bottom line is we need to see job losses. And job losses in the residential construction industry precede job losses overall. And you can think about it's the most interest rate sensitive portion of the economy.

9:30Housing is really the economy. If the housing market sneezes, the rest of the economy catches a cold, basically. So this is the dynamic we're really trying to focus in. We're trying to find that leading indicator. The other stat that I pull out for people is even though construction is like 5 % of total U.S. payrolls, in the average recession going back through modern history, it accounts for 15 % of the jobs lost during recession. So this is kind of a this is a labor force that's used to expanding and contracting more flexibly in these periods of weakness and strain. And so to me, this is a really important corner of the economic landscape that we should be paying attention to.

10:16The final thing is it's like four to six month lead between residential construction payrolls rolling over and your aggregate non-farm payrolls rolling over. And so that to me, it's the whole housing is the economy. So you need to focus on it. It's really difficult for me to envision a scenario where we have a true NBER defined recession and you don't get a slowdown in housing and residential construction payrolls. I mean, we're basically at the peak still. We're like fourth. We're very we're really right at the peak. We've basically flatlined in the last four months, lost a little bit, a few jobs here.

10:54But for the most part, this is not the trajectory you expect for some kind of pending recession. Hey, everyone, we're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

11:13So where is, so are we still seeing a shortage of workers? Is the market tight? Or is it sort of like balanced and tipping? Where do you think the momentum is for construction workers? So again, we really focus on - I think we do have that chart somewhere. I don't know if Brian did find it in time, but I think it was in some of the material that you passed along. If we could find that, if you could look for a Brian, that would be great. There was a scatter plot, Brian, if you have it. But if not, we're basically focused on units under construction. I think that's, and then you have to make a little bit of a couple assumptions about how many multifamily units, because like I said, a single family unit employs three workers for every one worker that a multifamily unit employs.

11:55If you think about that and you mix that in your equation, the bottom line is when you think about the stock of units under construction in the United States right now, we've gone from exceedingly tight labor conditions in the residential construction market to balanced. So this move we've seen from really one year ago to today where we've had housing activity slow down, all that's done is gone from a place where I can't get an electrician to call me back, even if I have a big piece of work for them, to maybe they're going to return my call. So the market's gone from very tight to balanced. The next step, if you're looking for a recession, you need to go from balanced to loose.

12:33And you're not going to get there starting building 80 ,000 new homes per month. like we did in May. Yeah, I think when you said that, getting an electrician come to your house, everybody just shook their head, raised their hand. Yeah, we have all experienced that for what seems like a while now, where it's so difficult because they're just flat out on giant projects. So they don't even have the time to return your call half the time. So super important stuff, Warren, and you really get in the weeds and break down the multifamily and single home, which is amazing. So the recession's pushed out, maybe not happening now, but we're talking late 24 if it happens based on what you're seeing now or even further out than that.

13:18So our base case is Q1 of 2024. Again, those are with much more pessimistic assumptions than what we saw in today's data point. Right, so you're gonna be watching now to see whether you have to change that, even push that out further. Right. So to take it one step closer to the goal is that we're looking for 7 ,000 residential construction jobs for the economy to shed 7 ,000 jobs every month from here into February, March of next year to hit that 8 % drawdown number that we're talking about. Now, again, that assumes that starts back off to like 60 ,000 units a month. And I just, you know, today is a day to reflect on all that and to think like there's a, for one, today's number just at least on the margin pushes that recession call back.

14:10So you have to adjust your model if you're looking at what we're looking at. So that's number one. If we stay at these levels, then I think that, like I said, we wouldn't even have a recession on the docket for 2024. That would be – yeah, it's really difficult to get to that place. So the question you have to ask yourself is, is this a reacceleration? Is this a soft landing? How does this go from here? And the reason I think that's so important is because I do believe the stock market's moving as if it's in a new early cycle move here. And the bond market, on the other hand, is positioned as if the Fed is going to have to cut rates a lot in the next, call it 12 months at the very least, and if not sooner than that.

15:03And so you have a huge divergence in what the stock market is saying and what the bond market is saying. So the recession call to me, this is why we titled the report about this recession timing the most important question. Because in our view, once you tell me where does the recession fall on the timeline, every other asset that's on the menu, its relative value really flows from that answer. And so the stock market at this point, the recent rally, I do believe, has fully baked this in. I mean, it is fully pricing. So if we did have a bad, if the economy did weaken from here, I think stocks aren't priced for it.

15:43If the economy continues to strengthen like this, I think it's very negative for the bond market. So, you know, we've had, we have inversions, especially in the very front part of the curve, which should suggest the Fed's going to have to go in there and cut rates. Those cuts get priced out. That bleeds into the rest of the whole, the whole yield curve shifts higher in my view. So that's what's at stake with this recession fall is really what's going to be, which market is going to be correct, the stock market with its positive outlook or the bond market with its negative pessimistic outlook. Absolutely.

16:13And as you point out, when we're talking, they're way off. They're in totally different universes right now. So they can't both be right. Is there a danger that they're both wrong, though? Are we going to have a repeat where, for reasons, both of those get hit? Like maybe, you know, how do you, this is, I think, why you're saying the timing is so important, isn't it? Correct. And that's kind of my base case. So my base case is that the recession, the stock market is going to be right in the near term. It's stock positive in the near term. But ultimately, I think you get a pretty nasty saw for the stock market.

16:52We do have a recession. It's hard for me, going back to the affordability numbers that I cited, it's really difficult for me to see how this persists. Just, you know, builder incentives and, you know, all the different kind of levers that are being pulled. I mean, is the U.S. consumer going to completely, is everyone going to in mass cut 50 % off the size of their new home builds? I don't see that. If you read through builder transcripts, that's not happening. The price points are still rising and things like that. So the numbers don't work. So at the end of this still is a slowdown, is a recession.

17:26And I think that disappoints the stock market eventually. But before we get there, I think the cycle is longer. It's just the theme has been a long cycle throughout this year. We came into the year, everyone expecting a recession. And every time you get a data point like this, it pushes that cycle out. I think the first market to be frustrated will be the bond market and the next market to be frustrated with the stock market. And so that's how I see it. Ultimately, the max amount of pain will be inflicted on all participants. Yeah. So this is super important because for everyone listening, we're all going to have to think about timeframe, right?

18:02So for the most part, if you're trying to make some calculations, and for keen viewers, you'll all remember that this issue of the timing of the recession has been the difference for a lot of forecasts, because, Warren, we'll have people come on and say, well, that person's saying the opposite of what the person who was on yesterday is saying. And longer term, they might feel the same, but it's that timing of the recession. So Raoul and Darius, for example, very different ideas about the timing of the recession when they were on together a few weeks ago. So everywhere we go, Jim Bianco is on last week.

18:38Everyone has a different theory, but like you, everyone's having to go back and revise it constantly because we're getting this information in in real time if you're trying to lead into the leading indicator. So a couple of people asking this question in the chat, including Colin and Joseph. So I'll use Joseph's. Does the Fed need to raise rates higher to hit payrolls? So what does this mean for the Fed? If the economy is showing this kind of resilience, you're at the Federal Reserve Board. You just decided to keep rates on hold or skip or pause, whatever you want to call it. What are you thinking?

19:13I mean, You're thinking you have to go again? On the margin, yeah. I mean, you may be able to, I think the Fed believes they're restrictive at the moment. I think there's evidence that suggests they're maybe not as restrictive as they think. And so if you're in the Fed's shoes and you think you're already into sufficiently restrictive territory, then it's just a function of time from here that they need to let that rate policy work through the system. So if it was me, I think what they could do is you're talking about the housing market, you're talking about borrowing channels, raising that front end.

19:48What we've seen is it kind of is it has this kind of perversely stimulative effect where it actually increases this interest income to a certain small segment of the population who already have a lot of money and then incentivizes economic activity through that channel. I think they need to really hit the borrowing channel. They want to slow the economy down and slow inflation down, slow down housing costs. And that would point to additional QT or more aggressive QT and balance sheet operations. And so to me, that has been an important point to watch for monetary policy is what they do with their balance sheet and quantitative tightening.

20:26And so to me, that's what if the world starts reaccelerating at a 7 % mortgage rate, which sounds insane to me. And that starts that housing disinflation that everyone expected to work through the system does not work through the system. Then the Fed's going to have to figure out a way to push those mortgage rates up. And I think the easiest way to do that, if you go back in history during periods of QT, the spread between mortgages and 30-year Treasury bonds goes from like 90 basis points to 300 basis points. So further QT where they're just, you know, sell, they're letting more mortgages roll off their balance sheet.

21:04That's a real drag on on on borrowing costs for the housing market. And so and that's where I think you end up eventually you have the buy the builder incentives and all that stuff that's going to run out of that's going to run out of steam. And there is an interest rate. I had somebody bring the builder incentives up to me and they said, well, you know, this is just the golden handcuffs and buy down rate buy downs and things like that. in the thought experiment if you think that's what's going on is okay if rates go to 20 tomorrow does that mean that you know builders are in even better position because it's going to have even fewer existing home sales and i think that the thought experiment should reveal to you that no that house whether they're new or existing or anything you have crossed the barrier where the economy can no longer support housing starts at this level with interest rates at that at that point.

21:55So that's the focus I think that the Fed's going to have is on their balance sheet and how they can impact those markets if they decide that that's fueling inflation further. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

22:16Yeah, it's interesting. And we've been talking about the Fed being really between a rock and a hard place. Roger Hearst just did a masterclass with Diego Perea earlier today. And Diego, very worried about inflation and what he calls a series of systemic bubbles. Let's have a listen to a clip from that. This is not a zero-sum game in the sense that when we abuse monitoring fiscal, we delay, transfer, transform the problems, we're effectively creating even bigger issues. And I think that's where we're now. We're sort of trapped in this dynamic between systemic bubbles that are too big to fail and the a problem of inflation as a result of this monetary and fiscal abuse.

22:56And I think this framework is proven to be very resilient, and it can help explain pretty much every single behavior from central banks and governments, from energy subsidies to bailouts to all sorts of interventions. And I think it will continue to dominate global macro and potentially is giving us a very strong hint of how the end game might look like. How are you thinking about the Fed's fight against inflation? I mean, is that the priority? Should we still be looking at systemically about what's happening with banks, about commercial real estate? How are you thinking about that? Yeah, I mean, that sounds like a pretty big picture statement.

23:37I checked that clip out before we went on air today. And so I'm familiar with it. It's a very big picture thought. And so the big picture thought that I'm trying to keep in my mind as we navigate this cycle is just, we added$8 trillion of debt over a two-year period or three-year period, basically. We've never done that before. You can go back to World War II. We've never done that before. And you have to all, everyone, myself included, everyone has to have a certain degree of humility about what happens next. And that, I think, has been really difficult for me, I'll be honest. It's been hard for me because we are historians, ultimately.

24:18We're quantitative researchers. And in this world, a quantitative researcher, you're just going through history and you're mining the data that you have. And we all have the same little slice of history to work off of. And now you go throw a variable like this into the mix and you add this much debt to the picture and you impair the supply side at the same time. So you impair supply via lockdowns. And then you stimulate demand via all this spending. And fiscal spending is much more impactful than anything on the monetary side. So you have these two forces that have hit each other. And of course, you're going to have inflation.

24:54And how that spins from here is really anyone's guess. And that's why when you get a number like this, which is really a trend break in the housing world, and you say, I can go back and say, OK, we haven't had housing this expensive since the 70s and 80s. We did see it in the 70s and 80s,$3 ,000 real home payments. But this is the first time really in 40 years or 45 years that we've had housing prices this much and we shouldn't be reaccelerating, but yet we are. And you have to ask yourself, am I missing something? Is that history that I'm studying too different from today to really inform my analysis?