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Welcome to our video #MacroMemo. We've got a whole lot to share with you this week. Among those things, we’ll look at the business cycle. We've updated our scorecard. I can share with you what we're seeing there in terms of the point in the cycle.

We'll continue to talk about the soft landing versus hard landing debate. And I would say the soft-landing odds continue to rise.

We'll talk about the number two in the context of 2% inflation, which of course, is the goal for many central banks, and certainly not an achieved goal for the most part. But we are starting to get some inflation readings that are in the twos, albeit in the high twos right now. So I think that's cause for some celebration.

We'll talk about China in four acts, that is to say, we'll talk about China in the context of its economy, policy responses, inflation and demographics briefly. And then we'll finish with a quick comment on the U.S. educational attainment and the fact that this is now starting to fall and whether that's a problem for productivity and so on.

Okay, so let's start with the business cycle. This is a scorecard we update quarterly and it canvasses nearly 100 variables and gives some estimates as to where we are in the cycle. And it has a grand time, by the way, disagreeing with itself. Different variables think that we're in a different point in the economic cycle, but we combine all of these and you do tend to get something of an interesting conclusion.

The single best guess of our current scorecard is that this is a ‘late cycle’ moment. Technically, that's a small step backwards. We had been getting ‘end of cycle’ readings a quarter ago.

I don't want to argue, though, that that's the main takeaway. I would say that's almost secondary. To me there are two other main takeaways. The first one is just that this scorecard isn't precise.

It's a rough estimate. And when you look at what it's saying, it's ascribing a pretty significant probability that we are in the late cycle, end of cycle or even recession. So those are the three final points of the business cycle. So the point here is that most of the indications, in fact, I believe about 66% of the inputs are pointing to a pretty late point in the cycle, speaking to a degree of vulnerability to decline.

I think that's probably the main takeaway. I will note one other thing, though. This is something we've seen a little bit of in the past, but it became much more prominent in this latest quarter, which is that you have a fourth category in the business cycle that's also starting to get significant votes and that is ‘start of cycle.’

Now it's less than 20% of the total. As I said, those later cycle assessments are more than 66%. And so here we are with no clear conclusion. The best guess is still that it's pretty far along, but you are getting a rising share and a non-trivial share, saying maybe this is the start of a new cycle and maybe we've avoided a recession and we're already starting anew.

The more likely scenario is that we haven't done that. But maybe the point is, or the secondary point is that our business cycle scorecard is acknowledging that a soft landing is entirely possible as well, and maybe that is in the process of happening.

Okay, on from there, let's talk again soft landing versus hard landing. The general theme has been one in which the soft-landing likelihood, the likelihood of avoiding recession, has been rising. The likelihood of tumbling into recession has been arguably falling somewhat.

Both are still entirely conceivable. In fact, officially, we're still saying a recession is a bit more likely than a soft landing. So certainly both are conceivable, but it is a moving target. And there has been some recent notable support for a soft-landing outcome. Recent examples in the data space would be U.S. payrolls rose by 353,000 jobs in January.

That was a lot more than expected. It was a fabulous number in an absolute sense. The ISM (Institute for Supply Management) Manufacturing Index is still sub-50, which is weak, but it rose by two points, which is a lot. It’s up to 49, which I guess mathematically is just barely below that 50 threshold but delineates contraction from expansion and it's the highest in 50 months.

And so we're seeing a positive trend there.

U.S. home prices are also tentatively rising. Housing is deserving of particular attention because of course it's such a rate-sensitive sector and here we are with notably higher interest rates.

It's also fair to say on the good news side of the ledger that some previous recession signals have unwound. We had been seeing a declining level of willingness to purchase durable goods.

That was a classic recession signal. We're starting to see that rise. It would be just about the first time it's ever risen without having a recession. But here we are with that metric starting to rebound.

We track recreational vehicle sales, RV sales, and historically, whenever you've had two consecutive years of decline, there's been a recession. We got those two years of decline.

We haven't seen a recession yet. We've now seen RV sales start to rebound. So there is a recession signal that just isn't clicking right now and has now turned. Similarly with inventory-to-sales ratios, we started to see inventory-to-sales ratios come back down. Previously when there was a spike, as we had seen recently, there's a recession.

We haven't had that recession. We're starting to see some improvement there.

Similarly, with profit margins in the U.S. stock market, when profit margins are falling significantly as they have over the last couple of years, that has always been a recession signal. We haven't gotten that recession yet. We're starting to see profit margins rebound slightly again.

So here we are again with just a set of traditional, in some cases historically failsafe, recession signals that just seemingly are now turning in the way that is pointing away from recession.

Similarly, some of the international data, Canadian GDP (gross domestic product) is looking a little better than expected for the fourth quarter, tracking 1.2% annualized. That’s not the 0% type of number that had been expected.

Eurozone GDP was zero in the fourth quarter, but the expectation was -0.1. That's perhaps a symbolic difference as opposed to a big difference, but just barely missing two quarters of consecutive decline.

Similarly in the UK, which is struggling, the composite Purchasing Managers Index is now up for a fourth straight month. It's sitting at a 52.9, which is well above the level of stagnation.

And so we are certainly seeing some good things. My net assessment would be the probability of a soft landing is continuing to rise. I do want to say, and this is just to confuse you all and really reflects the difficulty of forecasting accuracy right now,

It's not a slam dunk that we get a soft landing. We are still seeing things that argue for a hard landing. And you'd start with what I just said about the business cycle, which is 66% of the indicators are saying this is a pretty old cycle, one at risk of decline.

You know, theoretically, when you raise rates by five plus percentage points, there's supposed to be some economic pain somewhere.

It's hard to fathom there isn't going to be any suffering as a result of that. On that note, maybe we are seeing loan delinquency rates rising to some extent. So there are some issues beginning to be out there. Unclear how bad that becomes, but there is a bit of pain mounting.

We think some of the special things that particularly levitated the U.S. in 2023 are going to fade in 2024, including the degree of fiscal support and the level of consumer spending enthusiasm.

And we still do have lots of other recession signals that are still active, including things like inverted yield curves and shrinking global inflation-adjusted trade and falling U.S. temporary employment, and a Conference Board leading economic indicator that’s in pretty profound decline. And every time that's happened, there's been a recession.

So if you think you've heard me wrong, yes, I've said there are things that always happen and can generate a recession, and those are triggering things. There are also things triggering now that say there can't be a recession.

Obviously, both of those can't be right. So we're just getting a lot of contradiction right now. The uncertainty is higher than normal. There are two very conceivable outcomes for the economy. I think it would be misleading to suggest that one is a certainty and the other is an impossibility.

Okay, let's go from there. We'll talk about that number two I mentioned earlier.

Inflation is continuing to fall, although there’s certainly still work to be done. Still some risks, wage growth still too fast, among other things. But we are seeing progress and in particular, some pretty prominent inflation metrics are now in the twos. And so the PCE deflator in the U.S. is sitting at 2.6% year over year.

That is the Fed's favorite measure, purportedly. And the core PCE deflator is sitting at 2.9% for the first time, sub 3%. And so we're seeing some progress. To be sure there's still a big range of outcomes. And so median CPI is still running at 5.1% year over year. Some of the traditional CPI, core CPI is still a bit more than three.

So this is not a complete return to normality, but it is progress. When we look at three-month trends, a three-month annualized rate, we see even a little bit more progress. So those year-over-year numbers probably understate the improvement a little bit.

When we look at real-time metrics, they would suggest there is some scope for inflation coming down a bit further again.

The bottom line here is we are still slight optimists on inflation. We think there is some room for continued improvement. If we were to get a soft landing, it gets a little bit trickier because it's not clear the labor market cooperates and wage growth comes down, which might be necessary to get all the way back to normal.

So that does present a point of uncertainty. If you were to get a hard landing, it would be an easier journey down. But either way, we think there is room for some further improvement.

Okay, let's talk about China now. And so China in four acts. First, the economic situation is still quite weak for China. I would say, though, it's mainly a housing market story.

China is not in recession. China is still growing, albeit sluggishly. Really what's going on is the housing market there is very weak after having overinflated. It's big in and of itself, it's a big share of GDP, so a weak housing index, consumer spending, weak housing threatens lenders who have lent literally trillions of dollars to builders and in other capacities.

So we do have a below-consensus GDP forecast for China for this year of 4.3%. And we think there are some real issues, particularly in the housing space.

Let's turn to the second act, which is stimulus. From a stimulus perspective, we got a rate cut quite recently. We are getting some tentative fiscal stimulus. It's maybe a bit too much supply oriented, not enough demand oriented.

The issue is insufficient demand, not insufficient infrastructure and other things like that. There may be more coming in March, and we are beginning to see some stock market support for China. In fact, Chinese state-owned entities are now in the market buying in a big way, looking to stabilize the stock market there, which is I think a promising sign.

Act three is deflation. And so on the deflation side, China is in deflation. Chinese prices are falling outright. People are worried that China might export deflation to the rest of the world. I'm not that worried in part because I'm not convinced Chinese deflation sticks, and in part because of the rest of the world could use some deflationary pressures. Inflation is too high. That would be a welcome influence.

And in part because China exported deflation for decades, that was China making goods cheaper and cheaper and letting us buy more things and letting interest rates be lower and letting inflation be lower. And that doesn't sound like such a bad thing. So I'm not too, too worried about that.

I would just say the fact that China's in deflation says something about the weakness of the Chinese economy.

So it is indeed genuinely weak and more stimulus is needed.

The fourth act on China is demographics. China famously has a low fertility rate, but it's fallen even further in recent years. It's down to about 1.0. In other words, each generation you would expect to be half as big as the prior generation. And so that is pretty profound.

And there is a real scenario in which the Chinese population falls from 1.4 billion people today to just under 500 million by the end of the century. And so we're talking about practically a third of the current population, and that would leave it barely bigger than the U.S. at that juncture.

That's speculative. There may yet be things that change. But on the current trajectory, just given what we know even about fertility rates across Southeast Asia, it wouldn't seem unreasonable to expect that.

And that's highly relevant from a geopolitical perspective, from an economic growth perspective as well. And it's one of the very real headwinds that China faces, as much as China is still very much a global power player right now.

Okay. My last subject is educational attainment, specifically in the U.S., just flagging a trend that I think is a little bit counterintuitive, which is that we are seeing declining American educational attainment.

The percentage of the population with a college degree fell for the first time in 2022. The number of students enrolled in U.S. colleges has been falling slightly but steadily for a decade. At this point in time, the immediate college enrollment rate, meaning people going essentially straight from high school into college, fell from 70% in 2016 to 62% in 2021.

And so there is a genuine decline here. Some of that is due to the pandemic and fear of getting sick. A few years ago, we saw lower quality schooling during the pandemic and people didn't want to pay a lot of money for virtual schooling. So they just didn't end up going to the university. A strong job market pulled some people away. And so some are pandemic-related factors.

Those things might fade with time. Others, though, were more enduring, in particular just the cost of a college education, pricing people out altogether for those who can't afford it, making the return just less attractive, given how much more you might make with a college degree.

And so one way or the other, we've seen this decline in U.S. human capital and there was a risk to U.S. productivity growth if that were to continue, if the quality of human capital essentially keeps falling.

I would say we're still optimists on U.S. productivity.

We would say that the top end of U.S. society, the scientists, the entrepreneurs, the business people are still enormously impressive in a way that could just keep driving the economy forward, even if the average person is less educated. We would also say that just the scientific advancements occurring around the world are sufficiently exciting that there could still be fast productivity growth, even if the average American is less educated.

But the bottom line here is that it's not ideal that Americans are becoming less educated. That's a trend to watch going forward to see if it sticks.

Okay, I'll stop there and say thanks so much, as always, for your time. I hope you found this interesting and useful and please tune in again next time.