The US and Canada have avoided full-blown recessions so far, but consumer, business, and investor sentiment is low, one economist offers an explanation
This might be the least-loved bull market in recent times. Headline GDP and employment numbers in both the US and Canada are strong by historical standards, yet individuals rate economic performance as weak — both anecdotally and in survey data. Jared Franz offers one potential reason behind it: rolling recessions.
Franz is a US Economist at Capital Group, with a broadly more positive outlook for both the US and Canadian economies than markets appear to be currently pricing in. He offers rolling recessions as a reason for the gulf between topline performance numbers and broad sentiment. Rolling recessions, he explains, are when certain sectors go into recession without topline GDP showing more than a slowdown. With that concept in mind, Franz offered a broad outlook for the US and Canadian economies that could inform investors going forward.
“There’s this heuristic ‘law’ of economics that says whenever you get an inverted yield curve, you get a recession,” Franz says. “But lots of laws of break, it’s just hard to time when they break. What was clear to me coming out of the pandemic was that the labour market was fundamentally different in the US at least. Two thirds of the US economy is driven by the labour market because it drives consumption. In order to get a recession, something has to break in the labour market, and we just weren’t seeing that. The labour market has weakened relative to where we were a year and a half ago, but it’s nowhere near recessionary conditions. As long as the consumer stays relatively resilient, GDP growth should remain intact.”
While the US labour market informs Franz’s confidence about that economy, he says Canada is showing more fundamental weakening. In the last six months Canada has diverged from the US with its unemployment rate rising far faster. Canada, he notes, now has a supply of labour in excess of demand — largely due to mass immigration. He also notes though that there is a slowing in demand from the Canadian corporate sector. While the US has also supported its labour supply with some immigration, demand for labour in the US is still growing. That is no longer the case in Canada.
There is evidence of rolling recessions hitting both countries as well. Notably in manufacturing which has already entered its contraction cycle in both the US and Canada. Manufacturing is known as an area with relatively predictable three-year cycles of expansion and contraction. GDP growth can often continue despite manufacturing entering a contraction period. However, there is a risk of contagion spreading from manufacturing to capital expenditure, labour, housing, and other sectors.
In the US, Franz notes, we’ve seen contractions in manufacturing, trade, transport, and housing. However, the labour market has stayed resilient despite those rolling recessions. Those sectors — comprising roughly 20 per cent of the economy — have felt the shocks of higher interest rates and slight slowdowns in consumption. However, the other 80 per cent of the economy has held in and supported further growth.
Canadian sectors have experienced similar rolling recessions, with the addition of commodity-linked sectors which have struggled with significant price swings. The greater strain now being seen in the Canadian labour market, Franz says, may be a signal that Canada’s rolling recessions may turn general.
Despite the lack of a real recession, consumer and investor sentiment in the US and Canada remains muted to dismal. Franz sees myriad reasons driving those poor outlooks, but begins with the fact of high inflation. Unlike high unemployment — which only impacts a smaller segment of the population — inflation impacts everybody. Inflation creates broader-based negative sentiment about the economy. Individuals can see their real wages falling even as their nominal wages rise. Basic goods cost more and that makes citizens feel worse.
Add to that the shocks of inflation setting in over the course of the COVID-19 pandemic, giving people a meaningful timestamp to check their quality of life against. Media focus on topline numbers around GDP, wage growth, or market performance can also contribute to negative sentiment as people are told they’re better off now, while feeling worse off. This is especially evident in the housing market in both the US and Canada, where younger people feel squeezed by some of the worst housing affordability in history.
As rolling recessions spark fears of general downturns and cracks grow wider in the labour market, Franz says that investors need to stay wary and cognizant of the fact that in this unusual economic environment almost anything can happen.
“One of the fundamental views I have is that the world has changed, and the relationships we used to rely on like the inverted yield curve have to be taken with a grain of salt now, you can’t just rely on it working now because it worked in the past,” Franz says. “So be open to a wide range of outcomes and stay diversified because you don’t know what’s going to happen next.”
