Ep. 207 – 2023 1st Quarter Economic Update

In this Episode of the Secure Your Retirement Podcast, Radon and Murs speak with Andrew Opdyke about an update on the state of the economy of the first quarter of 2023. Andrew discusses the divergence within the economy, the issues with the banks, the recession and market volatility, and much more.

Listen in to learn why you shouldn’t worry about the US debt ceiling and its impact from a market standpoint. You will also learn why inflation might last longer and cause a recession if the federal reserve doesn’t prioritize the inflation fight.

In this episode, find out:

• The divergence within the economy – the goods and services sides of the economy are moving in different directions.
• The issues with the banks – how banks got hit from holding assets in a high-interest rate environment.
• Why the banking issues won’t lead to another financial crisis since it’s largely contained.
• Why the US dollar losing its world reserve status might be a passing conversation in the long run.
• Understanding the US debt ceiling and why it has a very little real lasting impact from a market standpoint.
• Why inflation might last longer if the federal reserve doesn’t prioritize the inflation fight.
• Andrew’s optimism on earnings progression, production growth, and service industry progression.

Tweetable Quotes:

• “The slowdown we’re seeing economically is not a collapse of activity, is that it’s become more difficult to buy that technology that keeps the output growth continuing.”– Andrew Opdyke
• “The debt numbers don’t tell you the full situation; you need to understand both sides of the balance sheet.”– Andrew Opdyke

Get in Touch with Andrew:

• LinkedIn: https://www.linkedin.com/in/andrewopdyke/

Resources:

If you are in or nearing retirement and you want to gain clarity on what questions you should be asking, learn what the biggest retirement myths are, and identify what you can do to achieve peace of mind for your retirement, get started today by requesting our complimentary video course, Four Steps to Secure Your Retirement!

To access the course, simply visit POMWealth.net/podcast.

Here’s the full transcript:

Radon Stancil:	Welcome, everyone, to our Secure Your Retirement podcast. We are excited to have you with us today. This is one of our favorite episodes that we do every quarter. We have on our economist, Andrew Opdyke. So first of all, before we go much further here, Andrew, thank you so much for buying time out of your schedule to hop on and have this conversation with us.
Andrew Opdyke:	Hey, I love to be with you guys. Thanks for having me back.
Radon Stancil:	Good. So one of the things that we love about having you all in every quarter is that it kind of gives us, we’re in the financial planning, looking at the whole picture from an individual’s perspective. And then sometimes we’re looking at the investment side of things. But obviously when things are going good, everybody’s happy, knows no worries. When everything’s being a little rocky, the client, the person who’s planning for and living throughout their retirement, they get like what the heck is even going on. So first off, before we start going into some specific issues, Andrew, could you kind of give us a high level of maybe some of the things you’ve seen here happen in the first quarter of 2023 and maybe compare that with even where you thought things were going to be?
Andrew Opdyke:	Yeah, absolutely. So the major question coming into this year was what was going to happen with inflation and the Fed? That was the major market movers of last year. The Fed obviously accelerating last year far beyond what they thought. But they ended last year with inflation high. And so coming in, there was a lot of questions surrounding are they going to do two rate hikes, three rate hikes, four rate hikes this year? How long were they going to keep rates elevated? Obviously recent events that have come up in the last month, month and a half, related to the banking sector have maybe shifted their course a little bit.
	But let’s take a look at the broader economic outlook because we are starting to see progress is still continuing. First quarter GDP, which we won’t get that number here for a few more weeks, first quarter growth was relatively robust. Jobs continue to come in strong. They’re starting to slow. We got data recently for the month of March. It showed that the job gains, while still above kind of quote unquote “normal” levels are coming back down. And what we’re really noticing is the divergence within the economy. If you look at the two sides, you’ve got the service side of the economy, you’ve got the good side of the economy, and those two sides are moving in very different paths.
	The good side, which remember, this is where we all went during COVID, this is where all the activity moved. When you couldn’t go outside, you couldn’t go to the airports, you couldn’t go to the hotels, you weren’t going on vacations, that side, the good side has kind of moderated and I would say even that side is probably in a recession today, but services have been picking up the slack. The question right now on the Fed’s mind is inflation has not come down yet, but as you see weakening, which side of the table is it going to stand on? Is it going to prioritize economic growth? Is it going to prioritize inflation, which is what Powell’s been saying? To be honest, it’s kind of like we’re going through that mid-seventies period all over again. Is Powell going to be Burns? Is Powell going to be Volcker? And what’s happened recently with the banks has made that a more difficult conversation.
	Now, real quick on the market side, markets are up. And you’d think with some of this volatility, you’d think with some of the issues and some of the slowdown, that might be some headwinds. But what we’ve seen is areas that got beaten up last year are kind of leading the charge this year. But again, there’s a lot of questions, can it sustain? So that’s kind of where we sit here at the beginning of the second quarter of the year, and I’m sure there’s going to be more volatility and more surprises to come.
Murs Tariq:	Yeah, it’s interesting you say that the service side, the balance of the good side and the service side of the economy, we’re here in the Raleigh, Durham area, and we have a pretty large airport, and I’ve noticed that some of the direct flights that got cut back during COVID times are now coming back. So that service side of the industry is broadening back up and recovering a little bit more. So I think that’s a good thing.
	You touched on the banks, and I think the banks are just so timely to talk about. And we don’t have to go into the weeds as far as what happened with the banks, but I think everyone’s worry now is, well, something unprecedented has happened as far as FDIC coverage goes and everything like that. But more of my question is, is you’ve got this new look on the banks from a regulation perspective, and I believe, I think that there’ll be a tightening on the banks as far as how they are able to give out dollars. And so does that start to push us into maybe what the Fed is looking for in a different way to start to push us into this recessionary type of environment?
Andrew Opdyke:	Yeah. Honestly, what happened with the banks, and let’s just step back real quick because this is, I know for a lot of people, they remember the financial crisis, they remember the housing crisis, they remembered the banking issues that surrounded that. And back then we had things, for example, with mortgages where people stopped paying their mortgage and some of those mortgage loans defaulted. This is not anything like that. What happened here essentially is US treasuries, which are supposed to be the safest asset in the world, the government will pay their debts, there’s a liquid market, they got hit. Banks got hit from holding these assets in an environment where interest rates went up.
	Now, I’m not going to dive too deep on that. I will say real quickly that I think the issues with Silicon Valley Bank, First Republic, some of those, it kind of ties into that discussion we had on goods versus services. That Silicon Valley Bank, for example, was very tied in with a lot of new business, IPOed companies, that really boomed during COVID when everybody said, “Hey, the world has changed. You need to get in in these new world companies.” Silicon Valley Bank, being at the hub of entrepreneurship, got really engaged in that. And when it turned out we liked going on vacations, we liked going to the restaurants, when the world started turning back, they got caught out.
	But as you mentioned, the regulatory side of this and the concern, if you’re a small and regional bank, here’s the thing. Most people, I would assume in your area, I’ll tell you for sure, in Chicago, most people had not heard of Silicon Valley Bank before any of this started. They didn’t bank with them. Silicon Valley Bank doesn’t have representation out here. They’re more of a West Coast bank. There was a lot of things where people were like, “I have no idea who these groups are. I have no idea how to evaluate what’s on the balance sheet of my local banks. Are they in a similar situation?” So banks started to tighten up. They started to hold a little bit more capital. They started to slow down on some of the lending.
	Essentially what the banks did is they kind of made another, I would argue it’s the equivalent of another rate hike from the Fed. I think that a slowdown in lending activity from the banks, which we’ve seen, and because these are small and mid-size banks, it’s particularly hitting small and mid-size companies. The big S&P 500 companies, a lot of these publicly traded companies are working with these major JP Morgan, Bank of America, Wells Fargo, the major banks who are less impacted by this. But yeah, it is kind of pushing towards further tightening.
	And here’s the way I would think about it is that when you see a slowdown in lending, when interest rates go higher, it’s more expensive to borrow and buy a house. And what would you expect to see? Fewer home purchases. What are we seeing? We’re seeing a slowdown on the housing side. When there is a higher cost as a business to borrow and invest in people, products, projects, technology, you see a slowdown. So the slowdown we’re seeing economically, it’s not a collapse of activity, it’s not that consumers don’t want to purchase anymore, it’s that it’s become more difficult to buy that technology that keeps the output growth continuing and you start to see it stalling out. It’s not a precipitous decline. It’s a bit of a stalling out. And this will contribute to it.
	I wouldn’t spend, just to tell people, I wouldn’t be overly concerned on what we saw from the banking front. I do not think that this is going to be another financial crisis. I think it is largely contained, but it has knock-on effects, and that’s what we’re going to be witnessing here over the next 3, 4, 5, 6 months. How much do banks pull back? How does this affect the Fed’s path forward? And ultimately, what does that do for US growth?
Radon Stancil:	Yeah, good. Yeah, we appreciate hearing your perspective on that. So let’s talk about another topic that’s obviously picked up some steam. I know in the past, and I can’t remember exactly what, but a few years back, the whole idea of the US dollar not being the reserve currency of the world kind of was a big topic. And then it died down and we didn’t really talk about it anymore, but now it’s kind of coming back in this conversation. Can you give us, for our folks that are listening, kind of give us maybe what the conversation is being had and then how your interpretation of that conversation about that.
Andrew Opdyke:	Yeah, so the US dollar has been for really about the last 200 years, the most important currency in the world. It is the currency in which international transactions take place. It’s the currency that other countries want to hold. They need it for trade. They want to have it to protect their own balance sheet. The reserve currency status, which in the past it’s been other countries, it’s been the UK if you go back 200, 300 years, it’s been China, it’s been other nations. Essentially, whoever has the most stable, most important currency in the world has a net benefit as a nation. There’s more demand for their debt. It keeps our interest rates lower. They have an easier ability to transact on an international scale. You have power. And so this reserve currency status, which is a major benefit to a nation, anytime that somebody has a reason to think that’s at risk, it makes headlines. And it’s a cycle that’s gone through every few years. We hear a new argument on why the US dollar is going to lose its reserve status.
	The latest arguments have been deals that have come up, for example, with China and Brazil. China went to Brazil and said, “Hey, we’re going to purchase commodities from you,” Brazil being a major commodity producer, “But we want you to pay for it in renminbi,” in the Chinese yuan. “We don’t want you to use US dollars anymore.” And Brazil, because they have so much reliance, they want to get that export activity. They want to have this production, said, “Sure, if that’s what you need, we’ll do it.” And a similar thing happened in the Middle East and people started to look and said, “Hey, they’re moving away from the dollar. This could be that pivot moment. This could be the moment that the US loses reserve status.” And if that were to happen, interest rates here, US treasury rates, the cost for government borrowing would go up. That knocks on the consumers, that knocks on the businesses.”
	Now, I’ll tell you this. We hear this story every few years. And again, it sounds interesting, but you really have to dig into what is taking place. The greatest benefit the United States has, the reason it has been the dominant currency, is because we have the US Constitution. It’s because we have private property rights, rule of law, democratic system. And because of that, right now, even with these changes, about 60% of reserve balances internationally are held in US dollars. About 60 to 70, 80% of international transactions take place in US dollars. It’s one of those things that we always have to combat because the story sounds interesting and anytime China makes it into the conversation, people say, “Well, China’s so big. China’s so big, they’re the second-largest economy. We need to take this seriously.”
	But the reality of it is China represents about 2% of transactions. They’ve been trying to make that a larger number, but developed markets, developed countries, they don’t trust communism. They don’t trust a government who’s historically manipulated their currency. So well, this is almost assuredly something you will hear more about over the coming months. It is not something that I think will substantively change. And just like we saw two years ago, three years ago, four years ago, this is a passing conversation that raises fears, raises anxiety, and then ultimately it fades to the background as cooler heads prevail.
Murs Tariq:	I like your stance on that, and I think that a lot of the viewers will take ease in their minds as far as the way that you just talked about that, which is again, why we appreciate you coming on. You explain things in such a nice simple manner, because economics is not always for everyone. It’s not always something that is easily graspable. So you explained things so well. While we’re talking about currency, I think it would be silly not to talk about the debt ceiling and where we’re at there right now. Obviously the US has printed a lot of money to get through the last couple years of stuff that we’ve had to deal with. And now the issue has become is are we way far under water than we’ve ever been before? And I think that the number is always going to be scary when we’re talking about debt and how far we’ve gone. But I think the argument against it that I’d like you to talk about is, well, you can have debt, but it’s all about your ability to service the debt, right?
Andrew Opdyke:	Right. Yeah, absolutely. I mean, think about it. Let’s say that you walked to your local mall and you stopped two random people that were walking out and you asked both of them, “How much is your mortgage?” And maybe one of them comes out and says, “My mortgage is $500,000.” Another one comes out and says, “My mortgage is $300,000.” Do you know from that information who’s in better financial shape? And if you think about it for a second, I think you’ll realize no, you don’t know from that alone. You need to not just know how much they owe. You need to know what their income is. If you’ve got that person with the $300,000 house and they’re making a million dollars a year and they can comfortably pay for this thing, and the person with the 500,000 is barely getting by, the debt numbers, they don’t tell you the full situation. You need to understand both sides of the balance sheet.
	And yes, US debt is at all-time record highs. And that’s true on the corporate side. I think it’s probably true right now on the consumer side. I know at least within some of the categories it is. But here’s the thing, US assets are at all-time record highs as well. And the number that I pay the most attention to is what percent of GDP, our US production goes to pay and service the debt. And right now, that number’s at about 1.9%. To put that in context, when debt was lower, but interest rates were higher in the eighties and the nineties, we were paying about 3% of GDP. So today, even though the debt outstanding is higher, because of our growth, because of our productivity, we are in a healthier balance sheet situation.
	Now, don’t get me wrong, I wish we would get spending under better control. I think that is critically important as we move out into the future. But the debt ceiling debate that you’re going to hear, it’s something that, again, it happens with a repetition. Every year, every two years you hear this debate on what’s happening with the debt ceiling and they yell at each other, they fight with each other, they kick the date down the road. If you remember back to the end of 2018, 2018 was a year where we saw the corporate tax cuts. We saw massive earnings growth from the S&P 500, and yet the markets ended the year down because people were worried, fears were high. What if this government shutdown turns into something bigger? What happens at the same time the Fed was raising interest rates, what if they threw us into recession? There’s echoes of 2018 today.
	What we saw back in 2019 is they do resolve these things. They’ll yell, they’ll fight, but we ultimately pay our bills. And if you hear on TV something that says, “Hey, we need to do this, otherwise the US is going to default on their debts,” that is just incorrect. The US can prioritize payments. We have more than enough that comes in in tax revenue to pay our debtors. I do not think we will see a US default. Quite honestly, I think what we will have the name calling, that this ultimately is going to resolve itself in a rather benign way, and then we’re going to move on to whatever the next thing is.
	But you turn on the TV, if you go online and you start reading the financial press, this is going to be headline stuff because it catches eyes, it catches attention, it sounds scarier than it realistically is. And those organizations, I mean, they sell advertising, so they’re going to talk about everything that could possibly go wrong. We’re risk-averse, fear-averse people. What our job is, and from an investing standpoint, one of the greatest things you can do is always look to put things in perspective. Look back to history, try to understand the broader context. Quite honestly, one of your best things is turn off the TV, dive more into the data. And what you’ll see is that while this heightens emotions, it tends to have very, very, very little real lasting impact from a market standpoint or an economic standpoint.
Radon Stancil:	Very nice. So what we like to do with you each time we’re talking, Andrew, is kind of conclude with this summary, if you might say. Kind of like the what are you worried about for the rest of ’23? And then what are you happy about what you’re seeing happening for the rest of the year? And if you could, in that commentary, let us know if we’re going to have a recession or not.
Andrew Opdyke:	Yeah, so let me start with the things that I’m worried about. Quite honestly, one of the things that I’m worried about is that the Federal Reserve with some of the volatility and everything that’s been happening has been kind of hesitant on really, really committing to the inflation fight. What they did with the banks, they stepped in, they added more money to the system, they started paying full value on assets that really probably weren’t worth it. They did essentially kind of a closet quantitative easing. My concern, one of the things that I’m a little nervous about, is that Powell’s acting more like Arthur Burns in the 1970s than Paul Volcker. And my concern is if the Fed does not address inflation, if it does not keep it as its top priority, that inflation’s going to be with us here for longer. And we are starting to see a slowing down in the US economy.
	I do believe, third quarter of this year, fourth quarter of this year, I do think we will see a recession. Now, not all recessions are created equal. That’s a blanket term. But this recession is not going to look like the ’08, ’09 recession. It’s not going to look like the 2020 recession. You want to look at a period of time, I would go back to ’90, ’91. It’s a slowing down of the US economy. It’s a flat to slightly negative type of economy because it’s become so expensive to invest in new technologies. That’s what I’m nervous about. I do think that there are still rocks along the way.
	The positives. What am I optimistic about right now? I do see that there’s progress taking place in other places. If you look right now, earnings have been coming down, and that sounds like a negative thing, and it is a negative, I’d rather have earnings higher than lower. But the path that we’re on right now, earnings this year are expected to be roughly flat with where they were last year. Now last year, people say, “Well, the markets were down. That was a tough year for earnings.” Actually, earnings last year set a new high, and this year earnings are expected to be right around the highest levels that we have ever seen in history.
	Pre-COVID, we were averaging about 160, $165 per share. Every share that you own in the S&P 500, that grouping, right now, it’s expected to be closer to 220. And that is real progress. That is real growth. We have seen production, we have seen output growth. We’ve seen people do kind of incredible things over the last two, three years, and those are things that are going to last us once inflation’s behind us, once the Fed’s job is done.
	So what I’m looking at right now, I still think that the service side of the economy is going to continue to progress us here in the second quarter, but let’s just be realistic that we will see some slowdown. Once we get through it, I think we’ve kind of got some clear skies ahead. I think we can set off on another strong bull market run. The greatest thing, okay, I see through all of this is that the private property rights, again, the rule of law, the democracy that is so core to our system here in the United States has not changed. And we continue to see companies from around the world looking to be here. We see workers from around the world who want to be here. And when we look at the broader trends, we look at literacy, we look at education, we look at fundamental core pieces that drive growth for the rest of my lifetime and into my kids’ lifetime, those, I believe, are moving in the right direction.
	And so we will get back to it, but buckle up a little bit here for the second half of this year in particular. We’re taking some of the economic medicine for policy decisions that were made in 2020 and into 2021. It’s not the most comfortable, but it’s necessary in order for us to get to that sustained path where we can grow into the future.
Murs Tariq:	Well, that’s great, Andrew. I got to put you on the spot here. I think at the beginning of the year, you and your company were kind of coming out and saying that it’s going to be market-wise, a relatively flat year. Has any of that changed here as we’ve learned more about where inflation’s at, where the Fed is headed and everything like that?
Andrew Opdyke:	Yeah. Right now, no. Our target is still 3,900 for the end of the year, which is actually a little below where we are. Again, the market is up this year. I do think we’re going to see a little pullback on that. I do think as activity’s slowing down, when that R word, recession, really materializes that we could see certainly some market volatility. But as we approach the end of the year, if the Fed has done what they say they need to do, what they truly need to do, inflation can be starting to get in check. And I think 2024 would be a year for rate cuts, not dropping back down to zero, but to start to see an easing on monetary policy.
	As the markets look at that towards the end of the year, I think they start the rally that we see sustained into the future. The net effect of it slows down a little bit here in the short term as the recession hits, we start that recovery, I think it drops us, brings us back, but ultimately we’re largely flat for the year. That outlook we put out, I think it was in December of last year, is still what we’re targeting here for the end of 2020.
Murs Tariq:	Very good. Well, Andrew, thank you so much again for coming on and taking some time out of your schedule. We know you’re very busy. But our listeners, they love hearing from you. So thanks again for coming on and just sharing some of your expertise.