The chief economist of RSM US, Joe Brusuelas examines the prospects for recession, and what accountants should be paying attention to on behalf of their clients.
Dan Hood (00:02):
Welcome to On the Air with Accounting Today, I’m editor-in-chief Dan Hood. For a few years now, most of our energy has gone to worrying about the COVID pandemic, but now that is hopefully fading in Providence a bit. We can start worrying about all kinds of other things, including a perennial favorite, which is the future state of the economy with inflation and concern, a way that hasn’t been for decades and people worried about a possible recession. It seemed like a good idea to check in with Joe Brusuelas, he’s the chief economist at RSM US, to get his take on what we can all expect over the next 12 months. Joe, thanks for joining us.
Joe Brusuelas (00:30):
Thank you for having me.
Dan Hood (00:32):
So as you look ahead, are you sort of more optimistic or more pessimistic about the direction of the economy?
Joe Brusuelas (00:36):
Well, I think on balance, the risk or skew towards we’re likely to have a recession in 23 simply due to the lagged impact of both the inflation and interest rate shock that the economy is currently absorbing. My sense is we have about a 65% probability, so it’s not 100%, it’s not completely baked in the cake. But when you think about how between January and January, 2023, interest rates have been hiked significantly, well over 400 basis points with some left still to be done. It’s hard not to make the case that, say, take a ecosystem like housing. Well, I think that housing largely is already in recession, even if say the service sector most definitely is not. And Dan, as we look at this economy, it’s not a surprise that coming out of a once in 100 year pandemic that we’re likely to get the most different sort of business cycle, end of that business cycle and then recession that we’ve seen really since the end of the second World War.
Essentially what I’m forecasting is a non synchronized recession for the United States economy. Let me elaborate. My sense is that the interest rate sensitive sectors, housing, auto production in specifically manufacturing in general, will feel a very normal recession. But because the US household is still flush with cash at the end of the third quarter, there is 1.5 trillion in excess savings over 858 billion in the upper two quintile of incomes or the upper quartile if you prefer. I’m not so certain that some portions of the service sector are even going to feel like they’re in recession in 2023. If anything, it’s just going to feel like a slowdown and then the economy will take off again once the Fed begins to take rate. Once the Fed begins to talk about the potential for rate cuts and the equities market then resumes its upward trend.
Dan Hood (03:03):
It’s fascinating. The way as you talk about it is the circumstances are so unusual. I mean, we haven’t had a major pandemic since 1919 or something like that, so I can’t imagine it’s easy to figure out going on but that’s for despite that 65% chance it’s a sort of an optimistic pessimism, if you will, or it seems like.
Joe Brusuelas (03:24):
Well, it is. I mean, the alternative to the baseline forecast is that we don’t go into recession is that it feels like it’s just a mid cycle slowdown. The inflation peaks a little bit below where the Fed thinks it is, they can act sooner. And every time we finish a fed rate hike cycle, equities tend to take off over the next 12 to 18 months by 20 to 30%. When you see that sort of positive wealth effect build, that’s when the animal spirits in the economy begin to be released. So there is a non-trivial probability that we don’t go into recession that we just have a near miss. So we say, whereas the broader service sector really doesn’t feel it, it’s just to slow down. And then we work through the problems in housing, which is going through a correction. Make no mistake about it, we think housing prices are going to drop 12% next year across the board with places like Boise and Salt Lake and in Austin, Texas seeing larger reductions in pricing than that. And there’s clearly going to be a problem in auto sales at one point with interest rates moving higher. That being said, again, a once in 100 year pandemic where we shut down production and then supply chains don’t get reconstituted in a timely manner, and in fact we’re three years on and it’s just now are those price global supply chains and domestic supply chains beginning to normalize.
Dan Hood (05:03):
Gotcha. Yeah, you just said it’s weird and those are things to keep an eye on there. You mentioned housing auto sales, inflation rates, obviously what the Fed does and says almost as much as almost seems as important to what they say as what they do. Are there other things that particularly accountants should be paying attention to over the next year to give them a sense of where things are going?
Joe Brusuelas (05:25):
Well, I think if you’re an accountant, what you wanna pay attention to is just the condition of the household. First and foremost, you want to take a look at consumer sentiment, income spending. You wanna take a look at savings, and then you wanna really dig into employment prospects. If I’m an accountant, the number one thing that I’m looking at is are there enough people in the pipeline to fill the jobs that are available? It looks like that’s not going to be the case. It looks like we’ve had a structural shift in the number of people who are available and willing to work in the economy. That is between 1948 and 2010, the labor force grew by about 1% per annum. I mean, you could absolutely count on it, right? Well, that slowed to a crawl in the three month period, September, October, November to close out 2023, labor force actually declined.
So we’re going to see some structural changes to the US economy and the labor force going forward. It’s really going to make me think, okay, I really have to pay very close attention to my clients. I have to know what their needs are, what their labor force is, what they’re paying the labor force in order to really provide the array of services that we can offer. At R S M, we talk about be compelling, be digital, and be global. I have a feeling, even though there’s a grand decoupling out there of the global economy, basically the us, Europe, uk, Japan, and South Korea, decoupling from the Chinese economy, the global economy is going to be just as important to the accounting, auditing, and consulting services companies going forward than they ever have been.
Dan Hood (07:25):
Well mean, but they’re also facing the same staffing issues, if not more, or the finding warm bodies to fill spots. I’m curious just to about that the decline in workforce. Is that a participation rate thing? I mean, is the sense of people are stepping back from the economy or is it literally just the numbers aren’t there? I mean, they’re literally the people aren’t there.
Joe Brusuelas (07:46):
This is one of those issues that’s so important that you really do individuals a disservice by saying, it’s just one thing, so I’m not going to do that. Right? It’s the echo of the baby boomers Federal Reserve, Sherman j Powell is said repeatedly in speeches that there’s excess retirements going on, meaning people are stepping away from the workforce. Who did you expect to, but they’re doing it in a quicker pace than one might have expected. For many years. We knew that there was about 10,000 or so. Baby boomers retiring a day. That number’s now taking off second in this country. We have a problem talking to one another in a civil way, and it’s unfortunate that we can’t have in this country a rational conversation around the long-term effects of Covid. It’s very clear that long Covid is now playing an outsized role in damping labor supply.
At a minimum, there’s at least 600,000 based off census Bureau reports who they can’t work and they’re not going to be able to work in a traditional because of long covid. And as we take a step back and we look at the broader labor force, not just at that survey, we’re probably somewhere around 2 million people who are going to get knocked out of the traditional workforce, who may need to some retraining, get some more education or different education in order to reengage in the labor force in whatever way they could. And then there is the policy and pass around immigration. We’re just simply not seeing relief via the immigration channel that we would have in past decades. So it’s setting up or creating a really set of difficult decisions for people, whether they’re in the accounting business or they’re in another form of service business on how do they meet demand, expand their businesses, and increase productivity. And what what’s happening is that discussion around automation is now really picking up. And I think you are going to hear that quite a bit more, especially in the accounting field where, as you mentioned, there’s just not enough bodies in the pipeline via the education system to plug the existing demand there.
Dan Hood (10:10):
And are also, unfortunately, there are tools available for a lot of the automation that may need to happen, or at least they’re being, they’re in the pipeline, they’re being developed in a way that the new CPAs are not. Between RPA and AI and all that sort of stuff. I wanna, that’s good things for accountants to pay attention to. What should they be telling their clients? Let’s focus specifically maybe on business clients.
Joe Brusuelas (10:34):
Well, I think if you’re talking to business clients, you probably need to tell them that odds are that there’s going to be a slowdown in the economy and that it may end up in a recession that you need to take steps to increase your efficiency when you can need to maintain your level of investment and productivity, enhancing capital equipment, software, equipment, intellectual property. I know, especially if you’re a small and medium sized firm, RSM serves the mid-market that the uncertainty around the depth and duration of any slowdown or prospective recession would LA largely cause people to pull back. And traditionally that’s what they do. But because of what we were just talking about, those structural changes, the lack of bodies in the pipeline coming to fill the jobs, holding back on innovation, increasing efficiency and increasing productivity until a more certain environment is in place is simply not an option right now.
This really is going to be the real managerial challenge in 2023. And I think when we get on the other side of this in 24 and 25, we’re going to be able take a step back, look at our firms and really identify who the talented managers are, who is really in touch with not just their workforce, how their firm is managed, more importantly, the needs of the client downstream, and to give them a forward look on where to go. I can’t tell you how critical this is in my field. One of my friends Ben Bernan, he won a Nobel Prize this last year in part due to a paper he wrote in 1983, obscure to most Americans, but very famous among us group of economists around what to do when uncertainty is pervasive. And this is one of those times where we’re going to need firms to lead holding back’s, just simply not an option. And I understand, cause I talk to our clients, I talk to our people and it’s a rational first response. And I get that I’m not going to spend more money on innovation. I’m going to focus on the existing clients and try to increase sales to them. That’s not going do it in this business cycle as it ends. And it will set you up for non-optimal outcomes in the business cycle on the other side of this.
Dan Hood (13:03):
Excellent. All right. That’s good advice. You had mentioned RSMs focus on the middle market. I wanna dive a little bit more into that, but we have to take a quick break. Alright. Right. And we’re back with Joe brs, he’s the chief economist at R S M U S. We’re talking about all kinds of things about the future state of the economy, where it’s going, what accountants should be doing, what they should be telling their clients to be doing. Particularly we just came out and said, talking about that in this environment, this is not a time when they can afford to hold back keep their powder dry. That’s a natural reaction, she said. But it sounds like the best advice is to not do that, to get out there, stay innovating, stay pushing ahead. As I mentioned mentioned, we both mentioned RSM has a strong focus on the middle market. What are the specific trends or are there specific trends you’re seeing there?
Joe Brusuelas (13:51):
Alright, so to close out the year, our middle, our proprietary RSM middle market business index eased somewhat, but still shows incredible resiliency out there of the real economy in the United States of America. I gotta tell you, if you would’ve told me two years ago, we would’ve experienced an inflation shock that would take pricing almost to 10% increase on a year ago basis. And interest rates would increase well over a 400 basis points in the space of 12 months. I would’ve said that economy’s going to fall into recession. There’s a case for optimism out there around the resiliency of the US business community in the US household. Okay, that’s good. But what we are beginning to see is a growing difficulty in passing along those price increases. One of the more impressive things through the first three quarters of the year was that we were getting low single digits to mid-high single digits on respondents reporting back in that they couldn’t pass along the price increases.
No, they had pricing power, an uncharacteristic type of pricing power than anything we we’ve seen since I would say the era of hyperglobalization started in 1990. Well, they’re, they’ve been able to pass along those costs, but in the last three months of the year, we are beginning to see some problems. And indeed, when you have these sort of price shocks, business sentiment tends to sour, which we’ve seen. Now, one thing that, and again, I have a 65% probability recession, 35% probability of no recession. The forward looking view on revenues and earnings is that well over half of the respondents still think it’s going to be pretty solid. And so that that’s something to hang your hat on. And again, it’s why if we do have a recession, the depth and duration of the recession will forecasting is very mild and shallow. So I think it’s important we put some context around that.
And again, we laid out in the first half of the show why that is. But I think it’s got to do with a household that’s flush with cash, the structural transformation in the labor force that’s going to result in a very low employment rate. We only have the unemployment rate increasing from 3.7 to 4.6 by the end of the year, a million jobs, more than a million jobs lost. Sure. But that’s in 159 million individual workforce. That’s not exactly a reflection of your father’s recessions or the sort of things we saw in the post world, world War II area where we often saw six to 8% in your average garden variety recession, and of course 10% following the great financial crisis and 14% at the peak of the pandemic.
Dan Hood (16:59):
Well, you mean you talk about three to 4% unemployment. I mean, I can remember in the 1990s economists talking about 6% as being sort of, you couldn’t possibly go below 6% unemployment without runaway inflation. I mean, just the sort of goalposts have shifted or are sitting over, the economy has shifted in such a way that we’re now able to have much, much lower unemployment rates than we thought were
Joe Brusuelas (17:21):
In. Can I add something to that? Yeah, please. Because this is really important. If you’re out there and you’re working in an accounting firm and you’re thinking, God, this just what’s happening here, you should expect going forward that full employment in the United States is best characterized by a 4.4% unemployment rate. Take them step back, stop and think about it. That’s just not simply what I was told as I came of age, went into school and then went into investment banking that that’s not what I was told. I was told 6% and the old guys would really whisper, well, it’s probably more closer to eight. No, that, that’s not our economy anymore. We’re not going to have just simply enough people to meet all the needs. And so we’re, we’re going to have to make some changes. There’s going to have to be some reforms, and that’s probably a different topic for a different day.
Dan Hood (18:20):
Right. But once we figure out how to have civil conversations start once we
Joe Brusuelas (18:25):
Can talk to one another without throwing the glass of bourbon at the other person. Exactly. Yeah. Yeah. No, it’s going to have a much lower rate of employment. We’re going to have some higher inflation and that’s going to result in an interest rate that’s going to lead be a little bit higher than what we’ve become accustomed to over the past 15 to 20 years.
Dan Hood (18:45):
Right. Well, and I also also wanna dive a little bit, I mean, it sounds one of the first things people do is get a mindset change around what’s possible and what sort of baseline things look at, like you said, what what’s full employment look like? What’s a natural interest rate? Because for 30 odd years, since you started high, since the air of hyper globalization, people have gotten used to extraordinarily low inflation. I mean, I can remember as a tiny child thinking that inflation was something was double digit all the time. And we haven’t had anything like that in, well, like said since the mid nineties. So some understanding that these things that people have understood to be sort of fixtures aren’t actually fixtures and can change over a not too long period of time. I mean, 10 years, 20 years is not that long period of time.
Joe Brusuelas (19:29):
So if we were flying in Boeing 787 Dreamliner right now, I’d say, Hey, let’s, we’re at that cruising altitude of around 30,000 feet, but let’s really kick it in. Let’s get up around 45,000 feet. Let’s take the big picture. All right. We are at an inflection point with respect to the framework of how the global economy is organized, that it’s important to note that the decoupling of the US and the other major G seven economies from the Chinese is going to result in some major structural changes over the last 30 years, we became accustomed to very low inflation. You just think about the last 10 years, about, or before the last 10 years prior to the pandemic, inflation was around one and a half percent. It was nonexistent, really. Right? And goods were cheap. You could outsource cheap labor very easily, and that allowed the Federal Reserve to set a very low rate of interest, and that allowed a lot of risk taking that wouldn’t have otherwise happened.
Well, that decoupling is going to alter the form of globalization that we knew we knew. So I’m calling that period 1990 to 1920, the air of Hyperglobalization, and we’re moving into one of regionalization. We’re going to devolve into separate trading blocks, essentially. Okay. This is driven by geopolitical security concerns, which again, are a different topic for a different day and a different expert. And so what I’m seeing here is that, okay, we’re going to move from a period of insufficient aggregate demand to mop up all that supply to a period of insufficient supply characterized by those geopolitical tensions and persistent supply shocks because the price of goods is going to go up because we all have seen it over the past couple of months. What’s been the big signal in the global business sector? Apple is reducing exposure and then likely to end exposure to the Chinese production of very sophisticated ships.
They’re probably going to move production for their Asian operations so they can retain entry in those wealthy markets to place like India or Vietnam. And they said clearly they’re going to begin to buy the ships that are going to be made in the desert starting in 2024 in the Arizona desert. Now, what’s interesting there is the increase in the cost of that X one chip, that very sophisticated chip that allows me to walk around with my supercomputer in my pocket, that’s going to increase by 50%. That’s going to be passed along. And you know what? I’m going to pay for it. I can’t live without it. A lot of other people who are listening in on this podcast, I would suspect they’re going to do it too, which means we’re going to absorb higher cost. Okay. Does that mean this is the end of globalization?
Not on any terms. Does it mean that, in fact, what I think it means is we’re going to get a dichotomy that’s going to develop in globalization where higher goods prices due to the replatforming of supply chains to friendly nations and here in North America. But on the service side, the digital transformation is actually going to accelerate a government due security concerns can change the terms of interaction. Technology transfers are going to be constrained, capital investment may be constrained. We’re going to encourage firms and maybe even provide incentives and or penalties to make sure they only buy from friendly, reliable sources in general. And the United States or North American production facilities in particular right now in the realm of digital transformation and services. Well, it’s about ideas. Those ideas are fungible. They’re not so easily cut off. So it’s going to be interesting to watch how all this evolves.
Whereas I think we’re going to have two track former globalization, one on goods, one in services. The one on goods going to slow down, get more expensive. One in services is going to accelerate. And I still expect over time technology to be damp inflation. But that takes time right now, what that means is higher inflation and higher interest rates and the three regime changes, globalization, growth and liquidity. Well, they’re all changing regionalization a little bit slower. Growth. Growth. And of course, the central banks are not going to be purchasing assets. Interest rates are going to be higher, liquidity and capital will be scarce. What’s the bottom line here after that big picture outlook? It’s going to cost more to run your business, right? It’s you’re going to have to pay more for wages, you got to pay for goods, use the earlier stages of production, and you’re got to pay more for the services that you need to conduct basic business. And I think that will define the next 30 years or so.
Dan Hood (24:52):
Wow. It’s a pretty fascinating vision and a radical change from what we’ve seen for the last 30 years. I mean, the characteristics of the last 30 years are by the opposite of all the things you just described or mostly the opposite. So it’s definitely something people wanna be wrapping their heads around accounts, particularly as advisors to business clients wanna be thinking about that and be ahead of that and be looking for the signs of that change rolling through the economy. It’s pretty fascinating stuff. I wanna to come back from 45,000 feet or 30,000 feet a little bit. I just wanna briefly touch on the sort of long term impacts of covid. You mentioned long covid as a potential long-term impact on or contributing factor to the long-term change in workforce participation rates and or the shape of the workforce. Do you see any other long-term impacts of covid?
Joe Brusuelas (25:42):
Well, one of the major long-term impacts includes what we just talked about was the relocation of some supply chains and back to friendly or terrain or North America or the United States. I think that you are seen in real time the construction of life science supply chains around biomedical treatments and vaccines necessary to deal with the outbreak of an exigent circumstance in the healthcare sector. I don’t think that that’s going to go away anytime soon. And that’s an opportunity for expansion and business growth here in the United States. And I think that that’s something that is likely to be characterized in geopolitical strategic terms. As a kid, I grew up in Orange County, California, and the baseball teams I played for were sponsored by NASA and all the aeronautical engineering that was the core of that economy in Southern California. And I learned very early that we went to the moon not for science, because it was insecurity interest of the United States, and that legitimated a whole host of research and development that then paid dividends over the long term and does still to this day. Right? So my sense here is that the discourse around the reassuring or basically propagation of new supply chains in life sciences will be placed within the context of national security. That is why you are seeing industrial policy return here to the United States. It’s no accident that the United States government, one of the most unique bipartisan fashions last year, put 53 billion on the table to jumpstart a sophisticated supply chain around semiconductors. I wouldn’t be surprised. As we go forward, if you see other forms of industrial policy that targets life, science, supply chains
Dan Hood (27:48):
Certainly makes sense given the last three years and people’s heightened awareness. I’m always worried about that though, because over the past 25 years, every three to four years, there would be a giant set of cover stories on every major magazine that you would expect a time, Newsweek, that sort of thing, saying, we’re coming to a pandemic, we’re coming to a pandemic, we’re coming to a pandemic. And then we were thoroughly unprepared. So I mean you would like to think that they might be that proactive, but
Joe Brusuelas (28:14):
Well, I, I remember the bird flu, the avian flew on one hand. Yep. Seemed like a false alarm. But then I know from looking at it, Ebola, that was a near miss. We just barely skirted a real global pandemic. So we’ll see how these things unfold. I think it’s important to note that most of us economists are highly skeptical of industrial policy. We all saw the A trillion yen essentially flushed down the toilet in Japan. <laugh> as the Japanese tried to corner the electronics market, turns out that they weren’t going to produce the best screens, the best way to watch media. It turns out it was this group called Apple, which was on the ropes and ready to go bankruptcy at the time. Nevertheless, this is a decision that’s not financial. It’s not economic. This is now in the national security realm. So it’s a real thing that money’s on the table and it’s legitimate that that firms go after that business. And it’s in a good idea that those of us who are in the service sector figure out h how to get on board and provide much needed services for those firms who are involved in that, what’s going to be a very vibrant sector over the next several years. The thing we’ll all have to wait a decade for is will those firms produce the equivalent of the best chips that are only produced in Northwestern Europe and East Northeastern Asia?
Dan Hood (29:42):
Well, one of the thing you mentioned the Japanese economy. What things seems fascinating about that is that when governments deliberately try to pick winners and losers or deliberately try to shape the economy, they almost always fail. But when they do giant things like the space program that are purely written, the main point of the space program is national security edging out the Russians, et cetera, et cetera. The benefits that seem to flow for that are endless. When you look at all the things we’ve gotten out of sort of all the Cold War space and defense programs enormous benefits, but they’re sort of almost byproducts when the government isn’t planning to run the economy, they turn out to boost the economy enormously. Look at the internet as a defense program that did not have an economic purpose. It had defense purposes, but it’s become this enormous engine.
Joe Brusuelas (30:26):
Well, one of the reasons why I’m somewhat optimistic that we’ll see some early returns from this case in industrial policy is it’s not the government doing it. It’s going to be public private partnership. And I think that letting the firms drive the direction of the outcomes, let innovation research and development derive where the next set of funding will go is probably the better path. Look, there’s going to be access, there’s going to be waste, and there will be fraud. But we do need to have, especially those life sciences supply chains back inside North America, and it’s probably a good idea that the United States produce sophisticated ships on par with those made by Taiwan Semiconductor, those made in South Korea. In fact, Taiwan Semiconductor is going to be one of the big partners at what are two firms in Arizona, and I know that where I live in Austin, Texas, there’s talk of 11 new semiconductor facilities. I mean, this is real money and it’s going to alter the shape of the economy. Absolutely.
Dan Hood (31:41):
All right. Well, we’re looking ahead. This is a fascinating look ahead at how things are going to or may change. It’ll be fascinating and see how it plays out because it really is, as we should come to the right that it’s a major sea change in the shape of the economy that’s going to play out relatively soon. Joe Brusuelas of RSM US, thank you so much for joining us.
Joe Brusuelas (32:03):
Dan Hood (32:04):
This episode of On the Air was produced by Accounting Today with audio production by Kevin Parise. Rate and review us on your favorite podcast platform and see the rest of our content on accountingtoday.com. Thanks again to our guest and thank you for listening.