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A Soft Landing and a New Era
The U.S. economy has sidestepped a recession. How? Is this a major shift in the global economy, and if so, what will be the outcome for business?
There are indicators the economy is cooling, which is good from the viewpoint of the Federal Reserve since that is what they hoped to accomplish by raising interest rates so high, and so fast.
But what has apparently not happened is the much-anticipated recession that a long list of economists and corporate CEOs seemed to be wishing for (I am looking at you, Larry Summers).
Indeed, a large number of CEOs turned to headcount reductions in late 2022 and early 2023 to drastically cut costs in advance of that ‘vibecession’.
But today, there is a great deal of evidence that a recession is unlikely, and therefore, we look to be headed for a so-called ‘soft landing’ that avoids high levels of unemployment. As Ruth Simon and Sarah Chaney Cambon summarized,
Fresh economic data this week reinforced optimism that inflation can fall without the U.S. suffering a recession. Economic output accelerated in recent months on the back of solid consumer spending. Inflation cooled to 3% in June, according to the Fed’s preferred gauge. And wage growth, while still elevated, slowed, the Labor Department said Friday.
U.S. stock indexes were up on Friday. The Dow Jones Industrial Average and S&P 500 Index have risen for three straight weeks, with the broader index closing Friday at its highest value since April 2022.
“We’ve seen so far the beginnings of disinflation without any real costs in the labor market. And that’s a really good thing,” Fed Chairman Jerome Powell said Wednesday after the central bank decided to raise interest rates to a 22-year high.
What’s Going On?
How did the recession-predicting economists — and the CEOs who listened to them — get it wrong? Basically, they seem to be mistaking this new era for the earlier Great Moderation.
The confusion is complex, so I will try to lay it out in lay terms (just as well since I have no training in economics). I am paraphrasing Paul Krugman’s recent explanation.
In late 2022, most economists believed that the Fed’s increases in interest rates would decrease inflation, but that the cost would be a substantial rise in unemployment, which is what Econ 101 teaches.
But while the economy has cooled, the rise in unemployment hasn’t grown. Why not? What’s different in our current circumstances? Krugman points to numbers from the National Federation of Independent Business (NFIB), which surveys what small business owners are actually doing with their prices: raising or lowering them. Small business owners don’t necessarily track what the Fed or BlackRock have to say about the Economy with-a-capital-e, but they have their fingers on the pulse of their customers and competitors.
The NFIB survey results track the inflation numbers very closely. And here’s what the NFIB has to say:
The long anticipated, predicted, recession is nowhere to be seen (almost). Recessions can start quickly (2020 shutdown) and end quickly (2020 reopening). Or they can start slowly, for example, due to opposing forces like expansionary fiscal policy vs. contractionary monetary policy. The Fed staff (not the Fed Open Market Committee.) has changed their recession forecast to a “slowdown.” There is more talk about a “soft landing” and less of a recession. The shifting outlook is often confusing but even less clear is, can the Fed reach its 2% inflation target (P.C.E. deflator) without a significant slowdown in economic activity (e.g., slower wage cost growth)? The manufacturing sector is clearly slowing, soft all year (Institute for Supply Management index) but services are doing well (I.S.M. index). Business investment is solid (lots of government incentives), and housing is ignoring 7% mortgage rates.
Then Krugman threads the needle, saying what we have is
an economy in which inflation is coming down because of improved supply, not reduced demand.
If demand was down, the vibecessionists might have been right, and we’d be seeing a significant uptick in unemployment. However, the long-term supply of workers in the U.S. is highly constrained, so that would act as a brake on layoffs, even in a recession, at least for the tier of world-beater companies that BlackRock is looking to invest in.
But that’s moot since we are experiencing supply-side improvement as the soft landing is touching down.
Ok, if a near-term recession looks unlikely and massive layoffs and turbulence will be avoided, what can we expect in the near future of work?
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A Turning Point?
BlackRock, the world's largest asset manager with approximately $9 trillion under its management, is not generally a source of warm-hearted analysis about the evolution of business practices; instead, they offer their hard-nosed perspectives on where to invest, and why. They offer, in their 2023 Midyear Outlook, the somewhat startling observation that the world has moved into a new economic era, one of greater volatility and uncertainty, and one roiled by supply constraints [emphasis mine]:
The investment opportunities in this economic environment are different from those in the past, we think. We have updated our investment themes as a result, kicking off with holding tight. Markets have come around to the view that central banks will not quickly ease policy in a world shaped by supply constraints – notably worker shortages in the U.S. We see central banks being forced to keep policy tight to lean against inflationary pressures. This is not a friendly backdrop for broad asset class returns, marking a break from the four decades of steady growth and inflation known as the Great Moderation.
BlackRock has identified five ‘mega forces’ that they believe will be the wavefront of a new economic era, and which will transform business and work [emphasis mine]:
Digital Disruption and AI — ‘The resulting cost savings [from AI] could boost profit margins – companies with high staffing costs or a large share of tasks that could be automated stand to benefit the most. But they could also get left behind if they don’t adapt.’
Fragmenting World — ‘We think the Ukraine war and fraught U.S.-China relations have ushered in a new era of global fragmentation and competing defense and economic blocs –a marked departure from the globalization and geopolitical moderation of the post-Cold War period. We see a world where national security and resilience are favored over efficiency. Without significant tech-driven productivity gains, that will likely result in lower growth and higher inflation.’
Tracking the Low-Carbon Transition — ‘We believe the transition toward a decarbonized economy will involve a massive reallocation of capital as energy systems are rewired. These shifts are a result of competing economic catalysts and barriers – shaped by policy, technology and consumer and investor preferences – that determine how and when low-carbon technology will be adopted.’
Aging Populations — ‘Many Developed Markets, including the euro area and China, face a falling working-age population in coming years. The global labor force is growing more slowly than it has since the Second World War. Reduced labor supply limits how much an economy can produce and grow –and leaves fewer workers to support a larger non-working population. That impacts government spending and debt: per capita revenue from income tax falls, as spending on retirement-related benefits like pensions and healthcare rises. That could lead to more government borrowing, at a time when rising interest rates are already increasing debt burdens. Population aging is already a binding constraint on U.S. labor supply. We see opportunities in healthcare, real estate, leisure and companies with products and services for seniors. Investors may also consider how countries and companies are adapting differently.’
The Future of Finance — ‘There’s been a tectonic shift in the financial sector since the 2008 global financial crisis, with banks gradually losing their dominance amid new regulations, technologies and competitors. We see this year’s banking tumult as a catalyst that is likely to create opportunities for non-bank lenders.’
One startling conclusion regarding corporate relationships with workers is this:
The shrinking supply of workers in several major economies due to aging means a low unemployment rate is no longer a sign of the cyclical health of the economy. Broad worker shortages could create incentives for companies to hold onto workers, even if sales decline, for fear of not being able to hire them back.
BlackRock analysts imply they are inclined to invest in companies that hold onto workers in downturns because it will cost more -- and take more cycles -- to get them back on any rebound. That is a sea change for US companies.
What Will Be The Impacts on Business?
The most important change to business — as we move into this next era in the global economy — might be the need to retain workers in downturns.
In How the U.S. Economy Is Sticking the Soft Landing, Ruth Simon and Sarah Chaney Cambon spoke with a range of business owners and leaders, who almost without exception talk about how they are taking significant steps to retain workers:
Only 7% of small-business owners intend to reduce their workforce this year, according to the survey of roughly 670 entrepreneurs conducted for The Wall Street Journal by Vistage Worldwide, a business-coaching and peer-advisory firm. Small-business owners tend to be reluctant to lay off workers, in part because of their close ties to employees. Many say they still face hiring challenges.
“The mind-set a number of years ago was laying people off was painful and they knew it was going to be painful getting them to come back,” said Ethan Karp, chief executive of Magnet, a nonprofit providing technical assistance to manufacturers in northeast Ohio. “Now, there’s a lot of sentiment that it’s painful to lay them off and darn near impossible to replace them.”
Apple has avoided mass job cuts embroiling the tech industry. The iPhone maker is managing costs tightly and curtailing hiring in certain areas, while adding in others, Chief Executive Tim Cook said earlier this year.
“I view layoffs as a last-resort kind of thing,” Cook said. “You can never say never. We want to manage costs in other ways to the degree that we can.”
Freight railroads have retained workers this year despite declines in shipping volumes, a reversal from the old practices. Railroad operators made deep cuts during the pandemic and then struggled to rehire when traffic bounced back. One result, executives said, was erratic service; railroad operators lost out on additional revenue because they didn’t have enough train crews to meet demand.
These companies are making adjustments to a cooling economic background, but the value of existing, trained, and engaged employees has risen in this new era. Companies, therefore have a greater incentive to become more efficient, cross-training workers to make their businesses more resilient, streamlining outdated processes, and installing new technologies to increase productivity and lower employee stress and burnout.
There is a new premium to retaining workers in an era when their numbers are decreasing, and demand is high. That will change everything.
I expect that companies will find it affordable to invest more significantly in activities that make a real difference at a foundational economic level, such as these:
Childcare — The situation for childcare in the U.S. is horrible: it’s unaffordable for many, and, in many locations difficult to find. Fully subsidized childcare — on- or off-site — could be a game changer for many working mothers, in particular.
Training and Development — One of the main reasons people leave jobs is that they don’t feel there is a path for professional development. This starts with possible apprenticeship programs, for young people, and not just for blue-collar jobs, either.
Housing — In many parts of the country even full-time employment with middle-class pay does not guarantee opportunities for housing. As of May 2023, 31% of all households are spending 30% or more of their income on housing, 50% of renting households are spending 30% or more of their income on housing, and 21% of owning households are spending 30% or more of their income on housing. Some companies are taking action and building housing for workers to make it available and affordable. Amazon and Tesla are two examples.
These and other progressive programs are likely to be the new battleground for attracting and retaining employees, as the supply of workers grows even more constrained over the coming decade and beyond.
This is one takeaway from the five mega forces analysis offered by BlackRock, one that is general across industries. The investment fund is careful to warn that the impacts of the forces will vary greatly by industry, geography, and the specific situation of companies. And so a second insight to glean from this is fairly radical: if the disruption of these five forces is to be reflected in very inconsistent ways, the conventional ideas about investment may be overturned. For example, investing passively in broad market indexes may no longer be a safe bet, because of large differential impacts of the forces. Investors and businesses will need to adopt a new mindset about risk, and opportunity.