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Jurassic Recession

By Scott Poore, AIF, AWMA, APMA
Chief Investment Officer, Eudaimonia Group

In light of the last Jurassic Park installment this Summer, I thought it might be good to revisit the movie that started it all.  The original movie was released this same month in 1993 and broke ground for new box office success.  While the massive budget $63 million was questioned at the time, the movie went on to gross $914 million worldwide, and ultimately more than $1 billion in re-release.  For an action movie, it also set new heights winning 3 Oscars for Best Sound, Best Effects (Sound Edited), and Best Visual Effects.  Some trivia that you may not know - the infamous roar of the T-Rex in the movie is a composite of 5 different animal sounds - dog, penguin, tiger, alligator, and baby elephant.  The movie has so many memorable quotes, which should make this week's Musings all the more entertaining.  It's been a while since we experienced the 2008 Recession.  The potential recession on the horizon may feel like an oncoming T-Rex from the Jurassic era.

(Richard Kiley Voiceover) "Welcome to...Jurassic Recession..."

"Dodgson, Dodgson, We've Got Dodgson Here!"  One of the quotes from the movie that has become a cult meme classic is the scene where Jurassic Park computer engineer Nedry is negotiating a payment to steal some of the dinosaur embryos for a competing lab.  Nedry uses Dodgson's name and he rebuffs.  People across the internet and social media have used the scene to create a meme for whatever issue or person they think is irrelevant.  In this case, I've created one for the proposed gas tax holiday.  This type of relief has been proposed before and summarily shot down as a "gimmick."  Here's the math as to why it has not been seriously considered:

    Average Gallons Consumed by American Driver            41 gal / mth (500 gal / yr)
    Federal Gas Tax                                                                $0.184 / gallon

    Savings Generated by Gas Tax Holiday                            $7.54 / month

The additional savings from a gas tax holiday would barely get you a Happy Meal at McDonald's.  For the low-income family, it's not much help at all.  The reality is that to fix the current price of gas, production needs to be ramped up significantly.  Prior to the COVID pandemic, U.S. oil production was at 37-year highs.  During the pandemic, U.S. oil production plummeted 21%.  That was ok initially, because we were shut in our homes for a few weeks.  Then, demand picked up considerably by October of 2020, while production was still at 2-year lows.

At this point, we should probably take a trip down memory lane to understand how basic economic fundamentals operate.  As demand increases, all things (supply) remaining constant, prices will go higher.  If demand remains high and supply dips, prices will proceed higher.  If supply increases, all things (demand) remaining constant, prices tend to go lower.  If supply remains high and demand dips, price will plummet.  This is the way of the world and not just "evil" corporations seeking a profit.  As a side note, no one accused the oil companies of being evil when gas prices reached a low of $1.70/gallon during the pandemic!  The pandemic and the shift to "green" energy has caused refining in the U.S. to decline.  Oil must be refined before it can be used in vehicles.  The U.S. has lost 1.1 million barrels of daily refining capacity over the course of the pandemic.  According to the U.S. Energy Information Administration, the total number of refineries has dropped from 141 in 2017 to 130 in 2022.  In fact, when we look back at history, more times than not, the price of oil has been directly tied to production or demand.  As we stand here today, the price of oil is not related to corporate greed, but rather demand (which has remained high) and supply (which is still low).

"Hold On To Your Butts."  After the deceptive Nedry escapes and the park operator Arnold is forced to reboot the entire system that runs the park, he tells everyone as he tells everyone watching, "Hold On To Your Butts."  That's the approach investors should be taking now that the economic data has weakened.  The University of Michigan's reading on June Consumer Sentiment hit a low of 50.0, a reading not seen in more than 40 years.  The Chicago Fed National Activity Index dropped from 0.4 in April to a barely positive reading of 0.01 in May.  The Kansas City Fed Composite Index and the KC Manufacturing Index also declined month-over-month in June.  While Housing data (New & Existing Home Sales), both the Manufacturing & Services PMIs dropped to 2-year lows.  On a broader scale, the Adjusted National Financial Conditions Index has now exceeded the average mark of zero to a positive mark of 0.08.  The last time that mark was reached was the 2nd week of the pandemic.  In addition, institutional money managers appear to be reducing their equity exposure and the "fear" or "panic" element of our Wealth Protection Signal is beginning to spike again as it did in early May.

We touched on the concerns about the current level of the Overnight Reverse Repo market (banks lending directly with the Fed) last week.  Not only has there been zero improvement, but conditions appear to have worsened.  Earlier this week, the total amount of Reverse Repos hit a record $2.29 trillion.  When we compare that to previous recessions, the current data is staggering.  In the six months leading up to the 2008 Financial Crisis, the normal Repo market (banks lending to each other) was averaging daily draws of $7.4 billion, while the Reverse Repo market (in its infancy) was averaging $4.7 billion.  Today, the normal Repo market is a paltry $0.001 billion (or, $1 million).  

The Reverse Repo market is averaging $1.794 trillion daily.  Equally troubling is that the number of counterparties (parties lending directly with the Fed) has ballooned in recent years.  In the first couple of months of 2021, there were 21 counterparties on average in overnight overnight Reverse Repos with the Fed.  In the last month, 97 counterparties on average have participated with the Fed in Reverse Repos overnight.  As a reminder, Repos are used during stable conditions and puts money into the system.  A Reverse Repo is supposed to be used less often by the Fed as it borrows money from the system when there is too much liquidity.  As we stare down the barrel of a recession, what happens when there is no liquidity and the counterparties refuse the Reverse Repo?

Hold On To Your Butts.....