Did Immigration Mask U.S. Economic Problems?

How population growth may have flattered the employment data, and why we saw the labor market as a turning point for the economy in mid-2024.

August is here… which means the holidays are around the corner… No? Is that just me? I feel like this year has flown by…

As the summer comes to a close families are squeezing in last minute vacations, kids are actively trying not to prepare for being back to school, and investors are closing their eyes as they enter one of the historically worst months for stock market performance in a calendar year.

If last year offers any guidance, we saw the U.S. stock market drop from mid-July to the end of October. It was only after the Fed’s policy shift, or hint, toward rate cuts that the U.S. equity markets took off from November 2023 to June 2024! Of course, eight months later, we have yet to receive any rate cuts and are now wondering if the Fed will cut rates once, twice, or possibly three times before the end of the year. However, inflation (or DISinflation) appears to be less of the reason for rate cuts. Instead, the focus has turned toward “balanced risk” which means the Fed is weighing high inflation against a deteriorating labor market (as I wrote about in the May market update).

In yesterday’s Fed announcement, Chair Powell pointed to the two recent inflation reports as promising but held firm to their belief that the Fed remains data dependent. As noted a few times over the last eight weeks, though, the Fed is beginning to pay more attention to the labor market as labor market deterioration continues to take hold in the U.S. economy (as I highlighted in my November 2023 market update).

This brings me to July’s update and what I am calling “The Turning Point”.

This update covers:

• The July market update
• The impact of immigration on employment
• The acceleration of unemployment

Are we headed toward a recession?

We start this market update with a continuing question, are we in, or headed toward, a recession? If we look at consumer spending (or the struggling consumer), the answer should be YES. However, if we look at Q2 2024’s GDP, we are led to believe consumer spending is alive and well, as GDP hit 2.8%. But if we look under the hood, we find that “non-durable goods” (e.g., paper, plastics, clothing, footwear, food, cigarettes) bounced back in a big way from Q1’s contraction. “The contributions to GDP growth from business inventories and international trade produced offsetting influences on growth last quarter. The change in inventories added 0.82 percentage point to growth last quarter following a 0.42 subtraction in Q1 and a 0.47 subtraction in Q4.”

But how does this contribute to the recession question? Well, for the last three quarters, retailers have been clearing excess inventory from their shelves due to year over year consumer spending declines. We have seen this in earnings reports by Harley-Davidson, Kering, Nike, LVMH, LULU, and many more. This means these companies need to restock their inventory with better price controls. If we then compare clothing and footwear brands like ANF vs. LEVI vs. ALO vs. LULU, we can see that consumers are being very picky with where they spend their money. For example, with denim coming back in vogue Abercrombie & Fitch has taken flight while Levi Strauss has seen their legs taken out. Or in the athleisure wear sector we have seen private companies Vuori and Alo Yoga begin to take market share from giant LULU. Although, it is important to note that brand leaders tend to take a period of time to adapt before reestablishing their brand’s dominance.

The same consumer pickiness can be seen in the services sector as well. CEOs in recent earnings announcements from McDonald’s and Lamb Weston point to the fact that consumers are stretched and are leaning toward staying in rather than going out.

Warren Buffett once famously said “when others are being greedy you should be fearful and when others are fearful you should be greedy.” This is probably why Mr. Buffett currently holds the largest amount of cash in Berkshire Hathaway. He appears to be prepared for attractive entry points in current, or new, positions.

For this reason, as noted in last month’s market update, we have started to nibble at positions I have been tracking for many months within our Core & Explore strategies. With small 1% allocations to each new position, after 20% to 60% declines from their respective peaks, we are finally filling out the portfolio asset allocations. Portfolios with short positions remain hedged. I anticipate these positions will be unwound over the coming weeks or months, but everything will be dependent on the macro and micro market trends.

So how does all of this tie into this month’s topic, “The Turning Point”?

For nearly a year, I have been deep in research looking at the central questions: what is the health of the economy AND are we headed for a recession? As noted in many monthly market update emails, the storm brewing under the surface has been building, but only recently have I been able to assign part of the “masked effects” for rising GDP and consumer spending. In fact, the White House’s June 4th Executive Order put a spotlight on the problem and supports the belief that economic deterioration will become worse, faster…

The impact of immigration on employment

Immigration reform seems to be a hot topic in most, if not every, election cycle. Interestingly, in this cycle it has become a huge issue as cumulative immigration numbers over the last few years have reached historic highs. To put this into perspective, between 2008 and 2020 the U.S. took in approximately 6,000,000 immigrants whereas between 2021 and 2023 the U.S. took in approximately 5,900,000 new immigrants. This means the unemployment rate was effectively suppressed over the last couple of years by a massive infusion of new people. Unfortunately, these new people will become a weight on the U.S. economy, or contribute to a quicker acceleration of the unemployment rate, as their jobs are potentially downsized.

To know just how much immigration has impacted the labor market over the last few years, I would draw your attention to President Biden’s Executive Order on June 4, 2024. Leading up to the Order, immigration started to level out, or slightly tick down, but after the Order capped new immigrants at between 1,500 and 2,500 per day (or 45,000 to 75,000 per month), immigration started to drop significantly. For example, U.S. Border Patrol reported approximately 137k new southern border crossings in March and approximately 83k southern border crossings at the end of June. However, July’s southern border crossings hit a low of approximately 56,000.

Now this isn’t to say immigration is the only cause for the rise in unemployment rate in April (3.9%), May (4.0%), and June (4.1%)… but fewer immigrants means a lower labor supply. Couple that data point with increasing initial jobless claims reaching a high last seen in August of last year, or continuing jobless claims reaching a high last seen in November 2021, and we see that the unemployment rate has a high likelihood of climbing further. This means if job openings continue to decline, companies continue to lay off employees, and immigration continues to decline (at least through the election), we could expect to see the unemployment rate increase to an estimated 5% to 5.6% by the end of 2024 (based on prior April to October cycles during the Great Recession and Dot Com Crash).

Bringing it together

So let’s bring this together…

If the Sahm Rule (a recession indicator) was triggered last month, ISM manufacturing employment falls further into contraction territory, immigration continues to fall and unemployment claims continue to rise, does this mean consumer spending will hold out or continue to crumble? I continue to stay in the defensive camp as we enter August and September… two of the worst months for investors during the calendar year.

The acceleration of unemployment

As I completed my research for this month’s market update, I spent a lot of time trying to understand how quickly the economy could deteriorate if unemployment (or a lower labor supply) further impacted the health of the economy. After looking at the 2000 to 2002 and 2007 to 2009 economic downturns, I came to realize deterioration is like a death by a thousand cuts… it takes quite a while. However, when the “turn” happens, it goes quickly… really quickly. For example, initial jobless claims bottomed January 2006 and slowly edged up until January 2008… then in a matter of six months numbers climbed substantially and continued to climb throughout the entire year. And yet, when I compare the Great Recession (2006 to 2008) to the Dot Com Crash (2000 to 2001), the deterioration of initial jobless claims seemed like an overnight change as initial jobless claims bottomed in April 2000 and accelerated into September 2001.

So how does this compare to where we are today?

Initial jobless claims bottomed in September 2022 and have remained range bound for nearly two years. Since the start of the year, though, we have seen initial jobless claims steadily increase to a level last seen in June 2023. However, if we look at continuing claims (which is a weight on the economy, as these consumers are spending less), which represent the number of people not able to find full-time employment, we see continuing claims bottomed in June 2022 before a 40% increase over the last 24 months. For comparison purposes, it took 12 months (April 2000 to April 2001) to see a 40% increase and 27 months (April 2006 to August 2008) to see a 40% increase in the prior periods of economic stress. Interestingly, in both cases it took six months (April 2008 to October 2008) during the Great Recession and six months during the Dot Com Crash (April 2001 to October 2001). Therefore, if history is an indicator of what is to come, the next 40% increase could happen by December 2024.

What it could mean for stocks

But how does this translate to equity market performance?

Well, if we look at the six-month periods mentioned above, I found the market-weighted S&P 500 declined almost 29% between April 2008 to October 2008 and almost 9% between April 2001 to October 2001. While I cannot predict the future, I can look at the previous time periods for 2022, 2008 and 2001. If I use these examples, and look at the government’s immigration policies along with increasing layoffs, I am concerned the market-weighted S&P 500 could drop from current levels.

If this were to happen, the S&P 500 could drop from August 1st to January 1st from 5,446 to 4,955 or… to 3,866…

Since past performance is not necessarily an indicator of future performance the next six months could be quite different… but if it follows a similar path then there could be some serious pain ahead.

For these reasons, we remain defensive, but opportunistic, with every market gyration.