How to Monitor and Prepare Ahead for a Recession

Currently, the economy is in a sweet spot: consumer and discretionary spending are still good, and businesses will still be doing well for themselves. While we’re confident that there won’t be a recession any time soon, that might all shift in 2024. If anything, there are early warning signs to look out for, and in the view of Piper Sandler’s Chief Investment Strategist, Michael Kantrowitz, it can be found using his HOPE framework.

The HOPE framework focuses on four key economic indicators:

• Housing
• New Orders (ISM)
• Profits
• Employment

According to the framework, rising interest rates will cause ripple effects that eventually affect all segments of the economy. The first to feel the pinch would be housing, followed by orders, profits, and finally, employment – the “most lagging part of the economy,” in Kantrowitz’s words.

These ripple effects don’t affect all economic sectors simultaneously. As Federal Reserve Chairman Jerome Powell says it: “We are seeing the effects of our policy actions on demand in the most interest-sensitive sectors of the economy, particularly housing. It will take time, however, for the full effects of monetary restraint to be realized, especially on inflation.”

We’ll be walking you through how you can monitor for signs of a coming recession and what you can do to prepare for it.

HOPE, Part 1: Housing

Housing outlooks generally rely on watching housing market indices, such as the NAHB/Wells Fargo Housing Market Index (HMI). This particular index is a “monthly sentiment survey” of over 900 home builders who are part of the National Association of Home Builders (NAHB). The index determines the “sentiment among builders of U.S. single-family homes” by rating current sales, prospects over the next six months, and the “traffic of prospective buyers.” A reading above 50 generally denotes a “favorable outlook” on home sales, while anything below that is the opposite.

The NAHB index rose seven points to 42 in February from 35 in January, a much better reading than the median estimate of 37. This is still good news compared to when 2022 saw a tremendous drop in sales not seen since 2008, with total home sales last year decreasing 33 percent. Higher interest rates will cause mortgage rates also to increase, but a Reuters poll suggests that average home prices may actually drop 4.5 percent in 2023, followed by a plateau in 2024.

That’s not to say people will be buying houses any time soon. The “average contract interest rate for 30-year fixed-rate mortgages” recently rose to “6.65 percent in the week ending March 2.” Just a year ago, the fixed rate was a mere 3.76 percent. If anything, the affordability of new houses remains suspect. It could cause a reduction in demand, which in turn will cascade into other sectors, such as construction or financial services, which are tied to consumer home-buying and related activities.

The rise in the NAHB index might seem like good news, but it doesn’t mean there’s no recession. On the contrary, a recession is still on its way but will arrive later than anticipated. So long as housing data remains weak, it’s too early to say if the economy will improve this year.

HOPE, Part 2: Orders

As the housing market fluctuates and mortgage rates go up, consumers will begin to feel the pinch and choose to be more prudent with their spending habits. This results in lower consumption of goods and services, so companies naturally react and reduce new inventory orders to eliminate existing/excess stock.

The ISM Manufacturing “Report on Business” and the Purchasing Managers’ Index (PMI) are consulted to identify trends in new orders. The PMI is a “composite index based on equal weights (20 percent)” that analyzes “month-over-month changes” in the level of production, employment rates, supplier deliveries, prices, and other criteria.

If the PMI reading is at least 50, or 50 percent, it indicates “growth or expansion of the U.S. manufacturing sector” compared to the previous month. Conversely, a PMI below 50, or 50 percent, indicates a contraction. The recent PMI is currently at 47.8 as of February 28th, a modest increase from January’s 46.9 reading. However, despite a slight increase in January this year, it still paints a less-than-stellar picture of ongoing contraction since April 2022.

On the other hand, the manufacturing new orders subindex of PMI increased to 47 points in February after a significant fall in January to 42.5 points. It’s been trending lower since last year, indicating that companies might be planning to gear up for a recession. They could either opt to delay their spending or investment plans, find ways to cut costs (which may include job layoffs), or increase prices.

HOPE, Part 3: Profits

Once consumer spending goes down substantially and reduces the number of new orders (both inside and outside the country), companies will start seeing diminishing profits as their expenses increase. We’re not currently seeing any significant downtrends in profits since we’ve not reached this stage of the framework – yet.

As it were, consumers may have indulged in some strong “one-off” spending from January to mid-February as they enjoyed their higher incomes. However, this didn’t last long, as card spending began to shrink towards the end of February. Part of this can also be attributed to the winter storms that buffeted some parts of the country, disrupting consumer spending.

But earnings are starting to slow, especially with housing prices increasing and consumer spending shrinking. This can be seen in financial expectations of changes to earnings-per-share (EPS) growth; EPS is defined as “a company’s profit divided by the outstanding shares of its common stock” or “how much money a company makes for each share of its stock.” EPS gives us an estimate of a “company’s profitability.”

The nominal gross domestic product (GDP) has been very high in recent years but is unlikely to get higher. And given how the Fed aims to keep inflation down and “cool” the job market, it will also put earnings under pressure. As this goes on, earnings will inevitably take a tumble.

This is reflected in the S&P 500 index, which measures the performance of about 500 US companies and offers a glimpse at the state of the stock market and the economy. Of the 370 companies that have shared their Q4 reports for 2022, “total earnings are down -5.8% from the same period last year on +5.6% higher revenues.” Prevailing estimates suggest “aggregate S&P 500 earnings” will be down “-5.5% on +5.4% higher revenues.” This is the first time S&P 500 estimates have actually turned negative since 2020.

Alarm bells are already tolling on continuing margin compression – where input costs go up faster than final sales prices. As prices continue increasing and consumer spending decreases over time, profits will also inevitably decline. In turn, companies will start to shed employees and figure out alternate plans to stay afloat.

HOPE, Part 4: Employment

The reason why employment is considered the most lagging indicator is because it only changes once housing prices, consumer spending, and corporate profits see a significant fall. It’s why we’re still reading news about how strong the job market currently looks.

Sure, the economy unexpectedly generated as many as 517,000 jobs in January this year, the most since July 2022. Job growth was also widespread, with plenty of new hires in various industries – particularly in leisure and hospitality (128,000 jobs), professional and business services (82,000), and health care (58,000). These were sectors that were hit especially hard during the Covid pandemic.

On top of that, unemployment is at its lowest in 53 years (at 3.4 percent) while compensation ratios are also low as companies did well as the economy recovered from the effects of the pandemic: corporate revenues had gone up 11 percent above pre-Covid trends for a total of $1.5 trillion. Recessions don’t start until (excluding other factors) compensation ratios increase.

But all those may be false flags to what seems like a solid economy. As the housing outlook weakens, the rest of the economy will follow, and employment will be one of the last to really feel its effects. Given the time lag of how changing interest rates affects the economy as a whole, it’s still too soon to be breathing a sigh of relief.

Making Preparations

Right now, we’re still in a sweet spot: consumer and discretionary spending are still in good shape, and businesses are still doing well despite the occasional tumble and the tech sector’s mass layoffs. However, that might all shift in 2024, especially with the warning signs of a recession based on the HOPE framework’s point of view. Housing, Orders, and Profits have seen some downtrends lately, and Employment may eventually show signs that it’s also taking hits.

In such a tumultuous and unpredictable time as this, you should begin futureproofing your print shop in preparation for an upcoming recession.

A Recession Will Hit Hard

The HOPE framework already shows how things can drastically change once a recession hits. Your shop will feel the pinch once the price of raw materials and supplies increases exponentially. You may find yourself desperately needing to get rid of inventory while the number of orders you receive dwindles when customers decide to save up for more important goods and services. Eventually, as profits go down, you’ll be forced to take up various cost-cutting measures and even lay off loyal, hardworking staff in a bid to stay afloat.

Even if you’re in a good financial position, you should never downplay the effects a recession can have on your business. Over time, you might find that your business accounts are beginning to run dry as you try your best to seek shrinking opportunities to keep your shop operating. It might be a little overexaggerated to think that way, but it’s always best to be safe than sorry.

Take this time to plan ahead for the rest of the year. What can you do to shore up your business’ position? Where can you find new sales if regular customers vanish overnight? Do you have contingency plans in place if things go south?

Be Prudent with Expenses

One suggestion we’d make is to be more cautious with where you put your business’ money. Are you planning to expand your shop to a new location? Thinking of buying new equipment to upgrade your existing ones? You might want to consider putting those plans on hold.

Interest rates are hiking, and the Fed plans on keeping rates up to bring down inflation. As a result, you’ll end up paying a lot more for that new shop location or the new equipment you’re considering investing in. It isn’t just cash or credit purchases that are affected; even leases are increasing in payment amounts. The last thing you want is to be stuck making payments while your cash flow is negative.

Moreover, if your sales have taken a hit, you won’t be able to get your return on investment when there are too few orders to make good use of your new equipment or location. If you really want to maximize your production capabilities for this year, then it’s worth looking at second-hand equipment you can buy in cash. Look for pre-owned equipment that’s still new or in good condition; if they’re fairly recent models, that’s a big win.

If possible, try doing more with your existing equipment: get more orders from a wider pool of new and existing customers, or get larger-scale orders that are profitable and keep your machines and staff busy.

Shore Up Your Savings

You’ll definitely need to do more to keep your business on track. Start by identifying where you can save on expenses: finding a new supplier offering more competitive prices or cutting out some unimportant things from your budget sheets. You could tweak your pricing structure to maximize profitability, but be careful not to get to a point where you could have more customers leaving.

You’ll also want to up your marketing game and have more promotions and special offers to attract new customers. Online platforms are a great and relatively inexpensive way to promote your print shop’s services; your existing customers can also point new customers your way via your online presence, which can help drive up new sales. All this ensures that you still have good cash flow when the recession finally hits and you can still keep up with all your current overheads and expenses.

Shore Up Your Customer Service

Customer retention can go a long way to keep your business in a good place. Going the extra mile with value-added services can make your customers feel good about doing business with you. Customer loyalty can be difficult to win and change in a heartbeat, so it’s essential to know who your priority customers are and give them the best service possible.

Naturally, you don’t want to alienate other customers you have, but if a major source of revenue comes from a select few, you also want to make sure they keep coming back to you. It’s a delicate balancing act you’ll need to pull off.