As the slow recovery from the Great Recession nears the end of its eighth year, many people are starting to wonder when the U.S. economy may next go into recession, and how that might affect the apartment market.
Predicting when a recession might begin depends on several unknowns that could happen at any time. And while the moderation in apartment performance – especially in locations such as the San Francisco Bay Area, South Florida, Denver and Austin – has many in the industry worried that it may indicate an economic slowdown, most of the usual signs of imminent recession have yet to appear, as job growth in the U.S. and many of these markets remains decent, Axiometrics analysts found.
On one hand, the length of the current recovery – 93 months as of April 2017 – is the third longest of the 11 expansion periods since the end of World War II. Should the recovery last past May 2018, it would surpass the 106-month expansion of 1961-1969. It would match the longest period, 120 months, in July 2019. Looking simply at the cycle, one could say the due date is near.
And when the unemployment rate falls below 5%, as it has in all but two months since January 2016, a recession usually follows within the next two or three years. For example, the unemployment rate started sinking below 5% in December 2005, and the Great Recession started in January 2008 — 25 months later. After the jobless rate fell below 5% in July 1997, it took longer before the tech recession hit in April 2001.
But the other usual recession indicators show we’re nowhere near a downturn. For example, a model that combines non-farm payroll employment, the industrial production index, real personal income and real manufacturing and trade sales put the recession probability at 1.4% in January 2017. A recession is thought to be imminent when this scale reaches 40% probability.
Then there’s the inverted yield curve, where the difference between the long- and short-term interest rates (10-year and three-month T-bills) can indicate an upcoming recession. Usually, the long-term rates are higher than the short-term rates, but when the reverse happens, it’s almost always recession time, since it means the long-term outlook is poor.
As seen in the graph below, the spread has been hovering in the 1.5%-2% range in favor of long-term rates for a while, so it likely wouldn’t be until later in the cycle before the short-term rate overtakes the long-term, especially with active Federal Reserve policy makers.
Three Recession Scenarios
So, the usual indicators are split. The current length of recovery and the unemployment rate point to a downturn sometime late in this decade. Others show that this recovery period, as slow as it is, will become the longest since the end of World War II and the next recession won’t hit until at least after the 2020 presidential election.
Axiometrics economists have developed three scenarios concerning the timing and depth of the next recession.
- Short-term recession in late 2019: The below-5% jobless rate the nation has experienced since 2016 takes its toll, and a cycle-driven recession hits in the third or fourth quarter of 2019. The current recovery will have just matched or slightly exceeded the 120-month record, and the economy just needs to relax for a little while. Since unemployment is already so low, labor costs will start to increase, forcing businesses to stall hiring or, maybe, switch to investment in machines rather than labor. With a slowing labor market, consumer confidence will impact spending. And since consumption comprises over 70% of the Gross Domestic Product (GDP) formula, it will negatively impact economic growth.
Should this happen, the downturn likely will be very short-lived. In fact, the recovery could begin before that 2020 presidential election. The past two recessions were driven by the bursting of a bubble in some sectors of the economy: technology in 2001 and housing in 2008, both of which could be seen inflating well before the bust.
No such bubble is occurring today. Yes, the energy industry has caused economic setbacks in certain areas of the nation – see job growth, apartment rent growth and occupancy issues in Houston, Midland-Odessa and around Oklahoma as evidence – but it hasn’t caused a national effect such as that which resulted in recessions in the 1970s and 1980s.
Without a provoking bubble, this downturn would be driven simply by the economic cycle. Industries will be quick to reassess their positions and can react almost immediately to return GDP to a positive level. In this scenario, GDP returns to its current rate of 2.0% by the second quarter of 2020.
- Longer–term recession in 2021: Fun fact: Starting with the 1960s, the economy has gone into recession near the start of every decade except the 2010s, when the nation was just starting to dig out from the Great Recession.
Should this scenario come true and we avoid recession in the short-term, the resulting recession would likely be longer and deeper than would a 2019 recession because structural issues would come into play and one or more industries would have a greater chance of bubbling. By this time, we may have also exhausted the continuous growth cycle. Thus, more industries will be correcting years of a bull run.
And once the correction takes hold, expect the affected industry to permanently lose a lot of jobs, such as what happened in the tech sector in the early 2000s and the housing sector more recently. In fact, the construction industry is still feeling the effects of the recession that ended eight years ago, as the construction workers who were laid off at the time have found higher-paying, more stable jobs in other industries. That’s causing delays in apartment development and is one reason single-family housing supply is so low.
As the old saying goes, “What climbs the highest falls the most.” A 2021 recession, after the longest recovery period in the previous 75 years, likely wouldn’t be as tough as the Great Recession, but it certainly would be more than a simple course correction.
- No recession in sight: Axiometrics forecasts apartment rent growth to rise again in 2018 and 2019 after a weaker 2016 and 2017, then continue apace in 2020 and 2021. A case could be made that the economy could do the same.
First, the average GDP during the current recovery has been 2.1%, significantly lower than the 2.6% average during the 2001-2007 expansion and the 3.7% in the 1991-2001 recovery. The slower growth means there is more room left for the economy to keep expanding. Especially if you take job loss into account from the Great Recession, the U.S. economy has only produced about 7 million jobs in the last 9 years. Historically speaking, this is well below the capacity of the U.S. economy.
Axiometrics’ model in the base-case scenario shows GDP rising from its current 2.0% growth rate up to 3.1% in the second quarter of 2019 before gradually falling back to 2.0% in the fourth quarter of 2021, the final period of our estimates. Negative territory is nowhere in sight. But keep in mind, we are not applying outside shock to the GDP forecast.
And, a little-known fact: Businesses may have more cash in hand than you might think. Those who were afraid of the Obama administration’s fiscal policies figuratively put money under their mattress during his first term, hoping he would not be re-elected in 2012. After he was, some of that money was retrieved, but much of it remained hidden during his time in office. That money now may be used as business confidence increases.
With household net worth increasing, mainly due to home equity and stock market growth, consumer confidence and spending alone can help avoid the short-term recession scenario. Having said that, business and consumer confidence alone cannot sustain economic growth for the long period of time if no material economic policies are put in place.
Whether this scenario is realistic depends much on economic policy set by Congress, the Trump administration and the Federal Reserve. The Fed’s current trajectory of regular increases in the base interest rate could keep the 10-year T-Bill rate well above that of the three-year T-Bill, holding off one indicator of recession.
And if President Donald Trump can deliver his goal of about 11 million new jobs by the end of his first term, pass through his planned $1 trillion infrastructure initiative and continue toward the path of business deregulation – which would give business and industry more freedom to operate and add jobs – the economy may well keep humming along in a slow-growth environment – but growth nonetheless. A more impactful policy option to avoid short-term dip, as proposed by the administration, would be to give both businesses and consumers tax cuts.
Of course, that would need a lot of luck and a lot of cooperation as the politics of Classical vs. Keynesian economics usually is not a clean fight. Healthcare failed the first time around, but will there be policy wins for the administration to impact the economic growth in coming years?
Any of the above three scenarios could happen, as could others not detailed. As we said at the start, predicting the next recession is difficult. But we’ll know it when it happens.