U.S. Macro Outlook: Mild Recession ≠ Pleasant



Other economic indicators also point to weakness ahead. The ISM Manufacturing Index fell below the expansionary threshold of 50 in November and continued to weaken in February, for a fourth consecutive month; of 18 major subsectors, 14 face contractions that represent 82% of manufacturing output. New orders plummeted more sharply than the headline index in January and continued to soften in February, helping to explain why manufacturing production has fallen month-over month for five of the last nine months, with the latest reading flat. Consumer sentiment, as measured by the University of Michigan, hit its lowest level on record (dating back to the 1950s) in June of 2022, and remains at historically low levels as of February. Abrupt changes in confidence tend to coincide with the onset of recessions with little lead time. Weakness in the housing market is another warning sign. As of January 2023, existing home sales were down 37% year-over-year (YoY), and new home sales were down by 19%. Home prices have already fallen by 5% since peaking in May 2022 and will fall further in 2023. On the housing construction side, real residential investment has pulled back by nearly 20% since the end of fourth quarter 2021. There have only been two times when the economy has skirted a recession when this has happened: in the late 1960s, when the yield curve signaled its only false positive; and in the 2001 dot-com recession. Mixed with labor market data, the signals about the economy are, in some ways, cryptic. A perfect example has been the resilience with construction employment thus far, despite the recent decline in real residential investment and the longer trending nearly 25% decline in real non-residential structures investment, which started at the onset of the pandemic. Typically, there is a strong correlation between real investment in structures and construction jobs, and the implied productivity drop-off hardly seems sustainable. In other words, the market data suggests job cuts are needed. The labor market has shown signs of cooling off—a necessary ingredient for quelling inflation. In the fourth quarter of 2022, the U.S. economy created an average of 291,000 net new jobs per month, a significant downshift from the 463,000 pace averaged in the prior three quarters. Still, the pace of 291,000 is well above 2000-2019 average of 183,000. Moreover, the first employment report we got in 2023 showed the U.S. economy added a blistering 517,000 net new jobs. Although we suspect this will get revised downwards and was impacted by seasonal factors, clearly demand for labor remains robust. The unemployment rate hovered in the 3.5% to 3.7% range for most of 2022 and is now at a decades-low 3.4%, with wage

• The U.S. economy will experience a mild recession in 2023. • Office – The age of trifurcation is here; strong demand for high-quality space and not enough of it. • Industrial – This is the year fundamentals will finally start to rebalance. • Multifamily – Looking past the near-term headwinds, the other side is strong. • Retail – No sector is immune, but retail enters 2023 with strong demand drivers. • Capital markets – The good news is there has already been a lot of bad news. • Niche sectors – Specialized sectors are becoming increasingly important to real estate investors. U.S. Economy: Defying Gravity for Now After a “numerically turbulent” year—with negative real GDP growth in the first two quarters—economic growth finished “in the black” in 2022 at an annualized growth rate of 2.1%. However, underlying data reveal that real domestic demand, while quite robust in H1 2022 in contrast to headline numbers, started to lose momentum in H2. Various indicators signal continued slowing in parts of the economy, if not a recession. Most notably, the 10-year vs. two year and 10-year vs. three-month Treasury yield curves have been inverted for months (since July and November 2022, respectively) and are at the deepest levels of inversion since the early 1980s. There has never been a period in U.S. economic history when both spreads inverted, let alone when the inversions have been this deep for this long, that wasn’t followed by a recession. 1 1 There has been one false positive in 1966 when using the 10-year to 3-month spread—that inversion’s steepest point was -49 basis points (bps). The 10-year to 2-year spread has never had a false positive. In our latest outlook report, we acknowledge we are making predictions during a period of heightened uncertainty (hence its 50% probability). To help our clients think through and prepare for all scenarios, we’ve included a base case scenario (which we feel is the most probable scenario based on our modeling and current market conditions), as well other scenarios for your consideration. The results for all of the scenarios we modeled can be found in the summary tables at end of the report.




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