622: Interest Rate Shock: What It Means For The Housing Market | Eric Basmajian, EPB Macro Research

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Okay, if you are wondering where interest rate, that is the trillion dollar question, quite literally, you are in for a treat today. We have Eric Basmajian, founder of EPB Macro Research with us and he is an expert on interest rates as well as many other things in the economy and the marketplace. And we're going to take a deep dive today with some good intel for you. So let's welcome Eric Basmajian. Eric, good to see you.

Hey Jason. Pleasure to be on.

Good to have you here. So interest rates, I mean, people are getting pretty worried. It is I think, surprising to some, including yours truly, how bold the Fed has been in their rhetoric about increasing rates. Given all of the turmoil that's going on in the world, what are your thoughts?

Yeah, so just to roll back about the way that I look at the world, I'm looking for inflection points in the economy. That's mainly what I do, APB Macro Research. I'm looking for inflection points in long term economic cycles, what we'd call secular economic trends and cyclical trends. So when I'm looking at the world, I'm trying to find out where is the next inflection point and how can clients position for what's on the other side of that inflection point. So what we have going on now is we have a Federal Reserve that was very slow to tighten conditions. Right. We had a big rebound in economic activity coming out of the COVID low and inflation started to run much hotter than they expected for longer than they expected, mainly to do with some of these supply chain issues. And then you threw oil prices on top of that, food prices on top of that. And what happened was the Fed should have started tightening policy somewhere between 12 to 18 months ago.

Yeah.

But they waited too long and now they sort of panicked.

And the problem I would agree with that assessment completely. It feels like they're trying to make up for lost time and. Exactly, it's, it's too shocking for them to do that, you know?

Exactly. So whenever I'm looking at any economic data point, I'm always looking at what's called the rate of change or the magnitude or the speed of the change. Right. Anyone that's a calculus expert will understand what I'm talking about in terms of the second derivative. Right. So what happens here with the Fed is they panicked and now, exactly like you said, they're trying to make up for lost time, but now they're pushing this rate shock onto the private sector and it's one of the largest rate shocks that we've seen ever. And this is going to cause a lot of problems here, Jason, because it's going to filter through to the housing sector, which is a key variable. And I'm going to share my screen here. I got a chart that really highlights this. Can you see my screen here?

I can.

So this is a composite index that I create that I publish to some of my clients. This is a private borrowing rate composite. So what I do is I take various private borrowing rates. So things like 30 year fixed mortgage rates, 5 year adjustable mortgage rates, short term commercial paper and triple B corporate bond rates. And I graph the 18 month change and the chart is inverted. So when the line is going down, interest rates are going up. So it makes sense with the economic cycle. And this is updated as of basically yesterday. And what you can see is over the last 18 months, private borrowing rates have spiked 157 basis points. And the only other two times that's happened was in the depths of the financial crisis when spreads were blowing out and ahead of the 2000 recession. So this is what we would consider in cyclical analysis, a long leading indicator. So what that means is it obviously comes down and it troughs before the recession and it starts to rise before the recession's over. So what the Fed did was they waited too long, they panicked and now they've pushed a record shock in interest rates onto the private sector. Historically, that doesn't end well, mainly because the flow through mechanism here is through housing. So just 12 to 18 months ago, people were able to borrow at 2.5% on a 30 year fixed. That rate's getting close to 5. So that's going to slow activity in the housing sector rather dramatically and that has a high multiplier effect on the rest of the economy.

Okay, so let's, before you move on to the rest of the economy, because housing is such a big part of it. As we talked about off air before, let's take a deeper dive into what you just said. Sure, you'd think it would be slowing the housing market, but Eric, I tell you, the inventory is so low. And here's the sort of toxic soup that I think the Fed has concocted that we may be eating for a long, long time to come, and that is that these artificially low interest rates we've had are going to cause people that refinanced. These are tens of millions of homeowners that have refinanced or purchased homes and they have locked in these rates for three decades. They're not going to give those up. They're not going to relinquish those mortgages because those mortgages literally now, I mean, I've been saying for almost 20 years that the mortgage is a huge asset. But now, and especially in the years to come, if rates go higher, people are going to realize that mortgage is the asset, it's not the house.

They're immobile, Right?

The problem is you can't take the mortgage with you to the next house, right? So therein lies the housing shortage that could last for 30 years. Am I wrong?

So what I look at is I am a analyst of economic cycles. So when I'm looking at economic cycles, we have what we call coincident economic data. That's what's happening in the economy right now. When people are going out and they're talking about what they see in the housing market, that's coincident with what's happening at the moment. Then we have what's called shorter leading economic data, which gives you a one to three, sometimes a six month lead time of what's going to happen to that coincident data. And then we have longer leading economic data which can give you maybe a 12 month lead time. Right? So what I just showed you with those private borrowing rates was a longer leading indicator. And that just happened, Right? It just happened. Basically this month we've had the biggest shock. So that's going to take a little bit of time to flow through to housing activity. So what we really want to monitor here is the sequence of events because that's really how you understand what's going on, Right? So what happens? The Federal Reserve tightens policy, or they guide that, they're going to tighten policy. Private interest rates or private borrowing rates spike. That's what we've just happened. So what would happen next in the sequence? Next in the sequence is we'd look for things like applications for new home purchases. That's an index that's published by the Mortgage Bankers Association. You can go and find the index for purchases. They do have a refinance index. Also I like to look at the purchase index that's been declining pretty sharply for the past several weeks in response to the higher mortgage rates. We're recording this on March 25th. Today was the pending home sales report. Pending home sales contracted for the fourth consecutive month. Now that would lead existing home sales by a couple of months.

Okay, but here's the problem with that. That can be very deceiving because in order to have a home sale you have to have home inventory.

So.

It'S funny to me that people will talk about, well, home sales are down, kind of implying that that's because, oh, the market's slowing down because everybody's fearful, they're raining in their horns, there's a recession on the way. You know what typical thinking, but a lot of times the sales are down because there's no inventory to actually sell, which means you're in a red hot market because everything's just getting gobbled up instantly and there's nothing to buy and people won't put their homes on the market. So which is it?

Right. That's another good point. We can look at applications for new permits for new construction as well, which is.

And then lag that by. By how long would you lag that? People differ on this, by the way.

So applications for new building permits in my analysis tends to lead the broader economic cycle by 6 to 12 months.

Okay. And now with supply chain shortages, you might even add 30 to even 50% to those timelines.

Correct.

And I don't know if those are today's timelines.

So you raise a good point and I want to address that. So what we're seeing is we're seeing a slowing of that or we're seeing a slowing of activity in the earlier leading indicators, which is going to flow through to the coincidence. But your point is, is this slowdown in activity because people don't want to sell their home or is it because people are backing off because of higher borrowing costs and worse affordability? My response to that would be in business cycle analysis, it doesn't necessarily matter because what we're looking through is the flow through of how the housing sector impacts the rest of the economy. So if you have no new home sales or no new construction and you have no existing home sales, how is that going impact employment in the construction sector? How is that going to impact hours worked or hourly earnings in the construction sector. This is another important point. The same thing is going on with the auto industry. Right. We've seen auto sales plunge with the chip shortages.

Meaning there's a car shortage.

Exactly. So you're correct in suggesting that auto sales have slowed, not really because of demand, just because they can't fulfill the supply. But let's say they can't fulfill supply for 3 months, 6 months, 12 months. At some point, an employer cannot pay an idle employee. Right. So if this shortage or if this slowdown because of the higher borrowing cost and worse affordability ends up creating a slowdown in activity and we see that flow through to eventually less hours worked in the sector or a reduction in employment, that's when you start to get a what we would call a vicious economic cycle where it starts to feed on itself. The opposite of a virtuous economic cycle.

Got it. So that would be a deflationary cycle, Right?

Correct. Correct.

Okay. However, can you have that, Eric, at a time? And I could show you a chart that would blow your mind about the construction cost index, as these materials are just so expensive. Now, Maybe it's transitory, but I don't know. I hate to even use that word. It's been so. It's been so abused by.

It really has. Yeah.

Yeah. What do you think?

Okay, so great point. So can you see this here?

Yeah. So this is personal income.

So this is real personal income, excluding transfer payments. So I take out what comes from the government in terms of stimulus payments, and this is just what's earned in the economy.

Right.

And this is adjusting.

No stimmies.

No stimmies. And this is adjusting for inflation. So real dollars, this is what we would consider to be a close approximation of the standard of living. Right. How do people feel in terms?

Right.

And what I did with this chart is I drew a trend line from the previous economic expansion from 2009 to 2020. And what we see is that because of the higher costs that have been pushed onto the private sector, whether it's construction costs or whether it's food cost or gas prices, what we're seeing is a rapid decline in real personal income. And this gap, the gap between the black line and the red line is basically how far below people's equ Expectations they are. So in economics, there's an important concept of long run income. So, Jason, if I was sitting there in 2019, when I go to make a big purchase, let's say I'm purchasing a home or I'm Purchasing a car or something like that. I'm not looking exactly at how I'm doing today. I try and make some extrapolation of where my income curve is going to be in the future.

If you're optimistic about the future, you're going to spend more.

Exactly. So in 2018, 2019, people were making purchases based on where they thought they would be. 2021, 2022. And what's happening is, in real terms, or adjusting for inflation, about 80% of the households are falling dramatically below those expectations. So this is going to at some point, and I believe that that is coming now, especially as these private borrowing rates have increased. That's going to result in a huge pullback in spending on these durable goods that are seeing the higher costs.

Okay, so let me play devil's advocate on this one for just a moment. Do you need as much income when the household savings rate is higher and other charts would show household income being higher? But I have a feeling you're going to pull up a chart that refutes that, which is fine. But here's what I really wanted to get to. When interest rates are so low, they're making the same large durable good purchase cheaper and cheaper because of the interest rate. Right. So automobile and house. Now, certainly the rates are going up as we've started the show with, but they're still historically pretty good. And I don't know, maybe the Fed is really just taking away the punch bowl just too quickly. So go ahead.

So this chart here is basically the same chart as I showed before real income, but it includes all of the stimulus payments. And you could see those spikes in the charts where the three stimulus payments were. And what's actually quite amazing is that inclusive of everything that the government has thrown at the private sector, we've still fallen below the previous Trend line from 2009 to 2020, when you adjust for inflation. So the inflation is damaging.

But that only happened recently and before it was way above the trend line, correct? Yeah.

So you mentioned the savings rate. Right. So the savings rate was massively elevated as of the last report. It dropped 6.4%, which was the lowest savings rate since 2013.

OK, so that's now old news, but it was the news for a while.

That's right. That was the last report. We'll get the new report in a couple of days. So the savings rate has come down quite substantially. And what we're going to see in my analysis, when you say the interest rates are still quite low, everything that I do is rate of change so it's. Is the interest rate rising or is it falling? Because when we look at economic growth, we're looking at it in a rate of change basis. Is not, it's not. Is growth 2% or 3%, is a growth slowing or is growth accelerating or decelerating? So if interest rates were 2 1/2% 12 months ago, there was a level of economic activity that was associated with those 2 1/2% rates. Now if rates are 4.5, 4.8, there's going to be a new level of economic activity associated with that higher rate. And that activity is going to be lower, not higher.

Yep. Okay.

So directionally the cycle is going to be losing momentum.

Right. And, and so the other part you have to look at, and this will go to the bear side of the equation, the bearish side, which is that of course the real inflation rate is a lot higher than the CPI rate. And I'm sure you use the CPI in your charts, right?

I do.

That's correct. Yeah. So real inflation, the real standard of living is even lower than what you're pointing out. Would you agree, you'd agree that the CPI is, is understated, I'm sure. Right.

Yeah. I mean, it's an impossible task that the CPI is challenged with because, you know, the CPI of someone in New York City is going to certainly be different than the CPI of someone in Idaho. The CPI of my, of my grandmother is going to be different than my cpi.

Of course, everyone has their own personal cpi.

Exactly. So it's very, it's an impossible task. But of course, home home prices are not in the CPI because they're considered an investment asset. The same reason that stock prices aren't in cpi. But people do have to buy homes. So we're looking at how far our dollars go and the standard of living measured in real terms, whether you use the CPI or inflation rate, that's closer to your personal basket, there's no question that the rate is coming down.

Yeah. Okay. And I agree with you, the standard of living is declining. So we can definitely agree there. The other part of it is when you look at a chart like that, that's sort of just the general population as a whole, but in an era have this, I think terrible and really it's going to lead to civil unrest, this concentration of wealth. Can the upper middle class and the wealthy just drive growth regardless of, you know, let them eat cake? Right. I mean, I don't think this is healthy, mind you. I'm just saying it's reality.

Right. No, you're exactly correct. And it's not healthy and it's a sad reality. But. But aggregate consumption is driven really by the top 10% of income earners. So.

And when we look at the housing market, you know, there's almost no first time buyer market anymore. I mean, you know, when I got into the real estate business years ago when I was 19, literally my first year of college, I mean, there was a such thing as the entry level house and homes for first time buyers. Now that whole segment of the market, builders haven't built that in probably 15 years. That's right. So the consumption in the housing world is all what would have been considered second, third and fourth homes.

Correct. There was a data point that I was reading just this morning from Pew Research and it's the percentage of 18 to 29 year olds living at home. Right. And in 2010, if my memory serves me correct, that was about 43%. And that was an all time high since the Great Depression. And that would make sense, right? We just had a financial Crisis. But from 2010 till now, or at least before COVID Let's take before COVID Let's take Covid out of the equation. So 2020, February 2020, from 2010 to 2019, we had what was considered a recovery in jobs. Right. There was several million jobs that were created. A lot of them supposedly went to this younger cohort. Explain to me how of young people living at home increased and was higher in 2019 than it was in 2010. And then of course today after Covid, it jumped even further. So demographics drives the demand for housing, Right. If there are less people or less bodies, you can't really sell more houses, right?

Absolutely.

There is this notion out there that the millennials are just as large of a cohort as the baby boomers and they're going to drive the housing market going forward. That's a narrative. That's not reality.

So what is the reality then in your eyes?

The reality is that the cohort that supports population growth and this is a chart that speaks to the global economic situation.

See, I was going to answer your question that maybe.

Please do while I pull this up.

A moment ago by saying, well, it's just cultural. Millennials are slow to grow up. Right? You know, that's one argument. Or they like their parents better than my generation, the Gen X generation did, or the baby boomers before me.

So can you see this chart here?

Yeah. Real GDP per capita.

Okay. So this is real economic growth per person. This is the best measure of the growth Rate in the standard of living. Okay. And with this chart, this is a 20 year annualized growth rate. So this last Data point here, 1.2%. What that means is over the last 20 years, real economic growth has increased at 1.2% per person. Right. And that's an average though.

That is not pretty.

That is not pretty. But what is really alarming about this chart for the people listening on audio is this nonlinear or parabola type decline that we've seen. So from 1960 to basically 2000, for that 40 year period, we sustained real economic growth per person of well above 2%. It was 2 and a quarter, 2 and a half, as high as 2, 2.75% for as long as 20 years. After the 2000s, we saw growth basically collapse. Now this parabola has fallen all the way to 1.2%. And as you mentioned, Jason, the income is skewed, economic growth is skewed. So if we have people whose standard of living is growing at 10, 20, 30% per year, year, and the average is one, that means that there's a significant portion of the population that's below zero. And if your standard of living is declining, you're not going to be able to move out of your parents home, buy the new house, have household formation, start a family. And that feeds into demographics. This is the 15 to 64 year old population growth rate. This is charted for Japan, Europe and China. And the reason this is extremely important is because when working age population declines, as I mentioned, you cannot sustain a real estate market. So what this chart shows is in early 1990s, Japan's working age population growth rate went negative. Japan fell to zero percent interest rates, they had a major real estate bust and they never recovered. They're still at negative interest rates. In 2009, Europe's working age population fell negative and they went to negative interest rates. And their real estate market never recovered. In 2015, China's working age population fell negative. And these numbers are way overstated for China. Their demographics are way worse than this chart suggests. But they went to negative working age population in 2015. And what happened in 2015? Any of your market listeners will know that China devalued their currency by about 2.5% August 2015. And they tried to reflate their property bubble one more time. But what are the stories in the news today in China? Real estate.

Right, Evergrande.

There you go. So, and then we look at the United States. It's the best.

Which is better off than anybody.

Better. Way better than anybody. Which is A big leg up for the United States. But the working age population is grinding to basically zero. And these numbers are as of 2019, these estimates were made and sadly the numbers that have come in for 2020 and 2021 are dramatically below what these estimates have suggested. So the real numbers are likely showing that the working age population in the United States is on the verge of contraction. Now again, this is a long, long, long, long term variable. That doesn't mean that the real estate market's going to go down tomorrow. What it does mean though, and the reason I extrapolated the estimates to 2030, is to imply what's the demand curve for housing going forward. Right. And when you look at this chart here, this shows the average consumption of housing and vehicles by age cohort. Housing and vehicles are the cyclical engine of the economy. You need people to buy houses and cars, so there's construction, so there's manufacturing activity, so there's production. And what you see is when you get past age 54, the consumption of housing and vehicles starts to really trail off. So you really need a robust population growth. Growth in this 25 to 54 year old bracket.

Sure. And you know, this would be Harry Dent's S curve. And you know, he studies this stuff a lot, although a lot of his predictions haven't been so great for a while.

That's right. And that's why, Jason, it's these are all secular economic trends. So if you're studying these variables, you need to have, and you need to be very clear that you're talking about a five plus year time frame. You could see in this top bar here when I say secular economic trends, three to five plus years. So you got to be very clear when you're talking about these things that you're not making a forecast about what's going to happen tomorrow. That's why you have to overlay. And what I do in my process is these cyclical trends. The cyclical trends you can see in that top black bar are what's going to happen in the next six to 18 months. Right. And what we're going to see in my view because of these leading indicators that I'm tracking is we're going to see a declining secular trend and we're going to now see a rollover of the cyclical trend. So we're going to see a decline in the growth rate. That doesn't mean negative growth, but the growth rate is going to come down. So we're going to go from four to three to two to one.

Okay. So nobody is talking about this issue. The baby boomers had really good economic times as they were passing through the decades. The 70s were tough, obviously, but overall the baby boomers did pretty well for themselves. And of course, the millennials resent that. Their, their own children resent that. But here's the reality. The next 10, 15, 20 years, those baby boomers are going to be passing on their wealth to their millennial children. Nobody is talking about that. You know, I guess it's just hard to see what that means. You know, what does that mean to the economy? What does it mean to the housing market? The baby boomers have money. So, any thoughts?

Yeah. So there is going to be a large transfer of wealth from boomers to their children. But what you can't pass on is income or employment. So if you get a large pool of money and it's managed properly, you can pull off a synthetic income stream and try and make that last forever. But if you don't have a, a income stream coming from employment and that pool of capital is not large enough, you're going to eventually eat that away and you're going to have a declining standard of living.

But I take for example, the real estate market and the baby boomers that, you know, there's about, what, 18 million or so single family homes owned by mom and pop landlords. Right. And the baby boomers own a lot of those. A huge portion of those, those rental properties. They own their own home, they own stock, they have assets, and it's just living off assets. Right? Right. Largely they have businesses.

So the question cuts two ways. Right. It's also who's going to buy the $1 to $3 million house that those boomers are selling?

And I've wondered that a lot too. Well, those aren't McMansions for 1 to 3 million anymore.

But now it's becoming, at least in the areas that in the east and the coast, that's becoming a standard house.

In any desirable area. You're not getting much for a million bucks anymore.

Right.

The McMansions that the baby boomers do own and it's, you know, interesting. I mean, I remember Harry Dent predicting this back in the 90s, that by about 2010-2013 there'd be a stock market crash and there'd be a McMansion crash because nobody was there to buy those properties. Right. Yet that's been wrong. Right. It's lasted a lot longer than he predicted. Maybe can't last forever. Maybe he's 10, 15 years late on his prediction, who knows? But I also get the sense that culturally millennials won't really want McMansions. They'll consider them un. Environmental. You know, it's just a very different.

They may concoct a story because they can't afford them anyway. Right?

Yeah, right, fair enough.

But going back to that prediction, I wouldn't predict a housing bust without the growth rate of the working population being negative and likely to stay negative.

Right.

So if you predicted this 10 years ago, it's not a surprise that it didn't come true because the growth rate was declining, but you still had more people in that, in that demographic. Now, if we had a curve that looked like China or Europe or Japan, where it was below zero and staying below zero for the next 10 years, I'd say, yeah, again, with high degree of certainty, you're going to have a real estate bust. The US however, is now over the next 10 years going to be a little bit of a trickier situation because these estimates, which are proving to be optimistic, are showing that you're basically going to hover at 0% growth in this prime age 15 to 64 year old cohort. The data that's coming in now is actually showing that it's trickling slightly negative, but again, that's a longer term variable. So I just wanted to clarify that point, that I'm not, not trying to go on record telling you that the market's going to crash tomorrow. But if you do want to understand where the next 10 years of a real estate market are going to, this is the absolute single most important variable to look at.

So you're saying over the next 10 years it will cool off.

I think that over the next 10 years the US housing market will cool off, especially in directional terms. Over the last 10 years that we've had was quite a remarkable 10 years in the US real estate market. I can't say because the curve of population growth doesn't look to be sustainably negative. I can't say that you're going to have outright declines or a crash. But you will not have a repeat of the last 10 years in US real estate.

Would you have that repeat if they get into another situation where they're loosening and just increasing money supply, buying asset purchase program, low interest rates? Does it come back at that point?

Well, it'll certainly be better than the mortgage rates at 5%. But what the Fed is ultimately doing, and it's taken a while to trickle to the real estate market because the demographics were somewhat supportive, is you can lead a horse to water, but you can't make it drink. Right. In economic research papers, this is called what's a liquidity trap? Right. You can push liquidity into the financial system, but you can't force borrowers to take it. And we've seen that play out with real economic lending. So when you look at something like commercial and industrial lending or any of the real business sector lending, it really has not responded at all to this increase in financial liquidity. It's all gone to financial transactions. Right. So if the demographic curve is incredibly negative, it won't support the real estate market. Case in point is Japan. They've been doing quantitative easing and have negative interest rates for the last 20 years. But their real estate market hasn't responded yet. Europe's had negative rates and quantitative easing. Their real estate market has expanded.

Well, that's really about you gotta have children.

It's really about demographics.

You can't have a country or a continent without children.

Exactly.

You know, you've gotta have demographic growth.

So no question it'll help if they buy up MBS and compress that spread again and drive the rates back down to two. Sure, it'll be a lot better than five, but either way, it's really demographics. If you're looking at the ten year picture.

Sure. Okay, show us some more charts.

All right, so let's flip over to the cyclical picture. We talked a lot about the longer term, what's going to happen with the demographics. But let's look at the.

And I do want to make sure, Eric, that I ask you your thoughts on the many, many people out there who are saying we have a housing shortage, 5 million homes short. Certainly we have a massive inventory shortage. I mean, and let me just give you the metric on that, if I could. So you know, most will tell you that for housing inventory at any given time, you need about 1.2 to 1.5 million homes for sale. We currently have about 241,000. So inventory needs to increase by 3 to 500% to be normal. That's not a recession recession, that's just balance. Right, right. You know, so what do you think? Is that, I mean, in your eyes, is that false or the building permits going to make up for that? Is there enough construction coming that it's going to solve that problem? Or is there a housing shortage of 5 million homes or some number like that?

Right. So two comments on that. First comment is that a lot of these numbers are long term averages. Right. We look at the last 50, 60 years of economic data and we draw a Linear average and say this is the average number of homes, homes per person, or this is the average number of supply and we're X percentage below that number, therefore we're short. But what we have to remember with the housing market is the demand curve is not linear. The demand curve is set by those demographics and the demographics are declining. So that linear average is not going to take us back to equilibrium. We're going to find equilibrium below that longer term average because the demographics are worse than they had bit.

So when you, when you look at a demographic chart, that is the, you know, the sort of pyramid shaped chart, the common one. Right. I mean, the US is so much better off than like any country, except maybe in the Middle east or Africa. Right. I mean, the US is just so much better off and it's very open to immigration, which Japan isn't right. You know, and Russia isn't right. Not that it has a ton of people knocking at its door anyway, but, you know, like our demographic problems can be solved without a birth rate.

It can be solved through immigration. Absolutely. But what's important to note is that in the last Census Bureau report, which was the preliminary 2021 numbers, we had a triple whammy of negative demographics. We had more deaths. Part of that was because of COVID of course, but we had more Deaths in the 25 to 54 year old bracket as well. So we had more deaths, we had less births, and we had less immigration.

Yeah. And by the way, some of that I want to mention, of course is opioid crisis, addiction problems.

That was in the 24 year olds.

That were exacerbated by Covid in the lockdowns.

No question. That was a. The fentanyl deaths were actually cited in the report because it was such a large percentage of the 25 to 54 year olds. But in the last administration we reduced the amount of immigration for sure. And then everyone expected that when we rolled over to this new administration, we're gonna have this resurgence of immigration, but we actually haven't. We're actually maintaining this lower rate of immigration than we've seen over the last five or ten years. So we could see these numbers reverse. Like Canada, for example, has a economic policy of immigration where they're trying to add a certain number of people per year to their country through immigration, which is helping their demographic curve a little bit as well. Well, so my response to you on the supply is that we are short. There's no question that the inventory is tight right now. But I would caution people when looking at this long term 50 year average of that's what balanced is. We're going to find balance at a lower level than we were over the last 50 years because the new demand is a lot less. But just flipping over to this new chart here, because I do want to talk about these cyclical economic trends or what's going to happen over the next six to 18 months. Months, because the longer term stuff we certainly hit on in the earlier part of the interview, I talked to you about what I called coincident economic data. That's what's happening right now. This doesn't tell us where we're going, this just tells us what's happening right now. And coincident economic data, you have to pull it from what I call the four corners of the economy. So you have income, consumption, employment and production. Those are the four corners of the economy. They move in a cycle. Every economy has those four corners. You take China, you take Japan, you take Europe, they may have more production than we do, but every economy has those four corners. So what I do is I take the best indicator of real income, real consumption, real production and employment. I smush them together and I create a composite. This is called the coincident index. And I look at the growth rate. So what you'll see in this chart for those people who are listening is through the end of 2020, through the beginning of 2021, the growth rate was rising rapidly. We had a lot of stimulus. We were coming out of the COVID lockdowns and the growth rate was pushed up to 8%. Then in April 2021, the growth rate peaked and the growth rate started to come down to 6 to 5, to 4 to 3. Now we're sitting at about 3.5% growth. And this is over the last six months, like a six month annualized pick picture.

Right. Which is definitely higher than the beginning of your chart in October of 2020.

Absolutely. So what's, what's important to note here is a couple of things. When we're trying, when we're looking at a recession, right. So let's talk about recession because that's what, that's what's starting to come into the conversation. With yield curves that are inverting is. Okay, so are we on the cusp of a recession? So I have four, three criteria that I use to identify. Is a recession an imminent risk? Right. Criteria number one is the direction of growth has to be declining. So that is satisfied the direction of growth is coming down. Right. Criteria number two is the growth rate has to be sufficiently close to zero. Right. So we have to be in the 1% range for a rest session to be imminent. You could have a recession occur in the 2% range if it's declining. And the reason is because the way recessions happen happen is the growth rate's declining, it gets close to zero, and then a shock hits the economy and the shock knocks a couple hundred basis points off growth. If we had a shock here in April 2021, with a growth rate of 8% and it knocked 300 basis points off, the economy would drop to 505%. Still no recession. But that same shock today could put us close to a recession. Right? So it's not, you know, when we talk about the war, is the war going to tip us into a recession? Recession, you got to look at where we are, where we're going and how close we are to zero. So we're not close enough to zero yet to say that a recession, or we're on recession's door because we're not close enough to zero. And the third criteria would be these are the four components broken out, right? So this is industrial production, the growth rate. This is employment, the growth rate. Consumption, the growth rate, and real income. The growth rate rate, one of these four has to be negative and zero, four are negative. Right. Now, this, bottom right, shows real personal income that will go negative in the next month or two because oil prices have spiked, food prices have spiked, and inflation's taking another leg higher. So when we look at the leading indicators to say, where are we going over the next two months? Let's say we're going to be looking at this picture. The growth rate is still going to be trending low. Criteria number one, satisfied. We don't know exactly where the growth rate is going to be. We have to look at the data, and real personal income growth will be negative. So criteria number three, satisfied. So we'll have to look at how over the next couple of months, this increase in interest rates, this decline in real income, and this increase in fuel and food costs, how does that impact broader consumption and employment? If it really impacts consumption and this growth rate edges closer to 1.5%, then I would say that we are getting closer to recession's door. But that's not my forecast at the moment.

Okay, yeah, very interesting. The thing that's impossible to account for, Eric, is we are in a centrally planned economy, obviously. And the reaction of the Fed, all of the folks saying the real estate market was going to crash, it was over when Covid hit, and then the exact opposite occurred. And you know, most of them admitted, well, I didn't know what the Fed was going to do. Well, of course you didn't know. But the obvious thing is politically they want everything to keep on going. Right. So the question is always what is the reaction going to be? But also maybe they've backed themselves into a bit of a corner.

Big time. Big time. So this time is not like the other times. Right.

Because hey, the saying is this time it's different.

Right, exactly. And, and this time the just what we call initial conditions are different. Right. Because the central planning of the Federal Reserve has really been heavy handed the last 12, 15 years. Let's say after the financial crisis. And in that 12 to 15 year period, we never had an inflation problem. They actually couldn't get inflation above 2% on the CPI. If they tried, they were trying as hard as they could, they couldn't get there. So every time you had a panic in the stock market, market or in stock market generally reacts faster than the real estate market. So let's say every time you had a panic in the stock market, the Fed was able to pivot and they were able to say we're worried. They call it financial conditions, which just means stock prices really. They would say financial conditions have gotten too tight. We're worried it's going to hurt employment, which is one of our mandates. Therefore we have to stimulate again. Fine. They can cloak that up and say that financial conditions will impact employment and it probably will would so sure. But they do have a dual mandate and they were never challenged on the inflation component. So they were always able to pivot very effortlessly. This time if you do have a little bit of a freak out in either the private credit market or the stock market and the CPI is 8%, they're either going to have to make a very clear statement that they really don't care about inflation or they're going to have to continue tightening policy into a panic in the asset market, something they've never done before. So this Fed reaction function, I don't think anyone has the real answer. We could all place our bets. But it's certain that the initial conditions this time around are not the same as they were the last time. So everyone can have their opinion on if CPI is 8% and the S&P is down 25%, what do they do? I don't know if we know the answer to that.

Yeah, yeah, I, I think you're right. We don't know. Thank you for all of the information and the visual charts included. If you are listening on audio only. Be sure to go to the YouTube channel so you can see Eric's materials, his charts and give out your website too.

Sure. So you can go to epb macroresearch.com right on the homepage I have a link that says learn about Eric's Secular and cyclical framework. I would encourage everyone to click on that. It's totally free. I don't ask for your email or anything. It's just a free document. But it's packed with my entire framework of how I think about the world. I start with the long term secular trends and then I go to how do I monitor the shorter term cyclical trends. So if you're interested in anything I had to say and you want to learn more about it, EPB macroresearch.com, it's totally free. It gives you my whole sort of outlook on how I see the world there.

Excellent. Eric. Thank you so much for joining us.

I appreciate it. Jason. Thanks for having me.

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