Financial outlook: The good, the bad, the unpredictable

Heather Graves

Staff

October 19, 2022

NORTHEAST WISCONSIN – Help wanted ads on nearly every corner.

Out-of-stock signs on numerous grocery and retail store shelves.

Supply chain disruptions across all sectors felt by companies throughout the country.

Quick and steep interest rate increases by the Federal Reserve.

You don’t have to be a financial guru to know something is happening – rising interest rates, market dips and increasing inflation.

Michael Hochholzer, chief investment officer and EVP with Associated Bank Private Wealth, said though things are concerning right now, it isn’t as bad as it’s being made out to be.

“‘The next crash is coming’ – it gets clicks, it drives people’s panic,” he said. “‘There are challenges out there, but we don’t think it’s that bad.’ Who clicks on that story?”

Hochholzer said you can unquestionably see the pessimism that’s out there.

“People at least at some level, are sort of prepared for whenever the next shoe to drop is, in terms of economic growth or recession and employment picture and those sorts of things,” he said.

2008 comparison
First things first, Hochholzer said what is happening today isn’t a repeat of what happened in 2008 – noting three “significant differences” — a solid banking system, more financially stable consumers and a strong job market.

“No. 1, the banking system is in much better financial condition than it was in 2008,” he said. “If you go back to 2008, particularly with the big Wall Street banks, they had leverage ratios of 20 to one. As we sit here today, those numbers are closer to nine to one, or possibly even lower than that.”

Hochholzer said the asset quality is substantially higher as well.

“The banks were lending money to people who genuinely probably couldn’t pay it back (in 2008) – the loan-to-value ratios were more than 100%,” he said. “None of that is happening at this point.”

Will Deppiesse, vice president of commercial banking, Nicolet Bank, echoed Hochlzer’s point, saying in 2008-09, home mortgages were being granted without verifying income.

Will Deppiesse

“You had people buying houses they couldn’t afford, and no one was checking to see whether or not they could,” he said. “When the music kind of stopped, everything cratered, and that was largely driven in consumer finance and home mortgage financing.”

Deppiesse said some are looking at the increased housing market today and attempting to connect it with what happened in 2008, but it isn’t the same.

“I think some people look at it on the surface that home prices have jumped a lot here in the last couple of years – ‘Oh, it’s ’08-’09 again,’” he said. “But the people qualifying for financing now are actually going through the proper steps to be able to get qualified for financing, so I don’t see the same kind of bubble.”

Deppiesse said the spike in the housing market is more of a supply and demand issue.

“Home prices have accelerated (today) because it’s more of a supply versus demand,” he said.

Hochholzer said the No. 2 difference from 2008’s crisis is that consumers are in much better financial shape now than they were in 2008.

He said about six to eight months ago, consumer savings accounts were at an all-time high – “in part because of COVID-19 pandemic stimulus; in part because of a restrained ability to spend the money.”

“We’ve come off of those highs at this point as people have been able to get out and spend money, but those savings numbers are still in really good shape by historical standards,” Hochholzer said.

He said similarly, and somewhat related, debt service ratios remain very near lows.

“Rising interest rates have pushed those up off the absolute lows, but by historical standards, they’re still really low,” Hochholzer said.

He said No. 3, and maybe the most important difference when trying to compare today’s struggles with 2008, is that today’s job market is still “very strong.”

Michael Hochholzer

“There are millions of unfilled jobs out there,” Hochholzer said. “You see the help wanted signs everywhere. We’re seeing some signs of that job market starting to cool, but it’s got a lot of cooling to go before you see concerns about the job situation.”
Hochholzer said psychologically, things are different as well.

“Confidence and expectations are already pretty low, in some cases at all-time lows, and if you look back at what happened in 2008, the world was wonderful and everything was great until things started unraveling,” he said. “So, it was that we’ll call it overconfidence, that set up the big fall.”

Today, Hochholzer said the opposite could be said.

“Consumer sentiments are at all-time lows, business sentiment is at all-time lows, or at least close to it,” he said. “People are expecting bad things and if they’re expecting bad things, they’re prepared for bad things. And it means when a recession does occur, it’s not the shock to the system we saw in 2008.”

Raising interest rates
Deppiesse said when the Federal Reserve gets into a raising cycle – like it is in now – “they’ve normally waited a bit too long.”
“And that means they need to respond a little bit more strongly,” he said.

Deppiesse said coming out of the pandemic, it was difficult to determine where things were at.

“So, I think the reason why the Fed waited a little bit longer was to get normal months over normal months from a prior year,” he said. “But then, no one expected inflation to be running at 8-9%, which is something we haven’t seen in 40 years. So, then the Fed realized, ‘Okay, we’re going to be forceful.’ They’ve raised rates multiple times here at three-quarters of a percent a pop.”

Hochholzer said part of that has to do with perhaps the only obvious excess in the current environment – excess demand. 
“And that’s what the Fed is trying to slow down with the rate increase cycle that we’re watching,” he said.

Deppiesse said this in turn impacts the markets because they are normally forward-looking, not backward-looking.

“So, when the Fed takes a stance like that… there’s going to be some pain in terms of economic growth,” he said.

Deppiesse said at some point, whenever the Fed starts to get data that indicates that inflation is more under control, then we’ll see the market start to go the other way.

“Feds are going to calm down rising rates when we’ve hit the peak, and then the economy can eventually go back to a growth mode,” he said. “But that all takes some time.”

The pandemic’s impact
Hochholzer said the seeds for the inflation issues we are faced with at the moment, were, in his view, definitely sown during the pandemic – a combination of things, with No. 1 being the fiscal stimulus.

“When the pandemic came, we shut much of the world down,” he said. “And legitimately so, the federal government stepped up and pumped a whole bunch of stimulus – I mean, just unprecedented, which was an overused word, but in this case, it’s legit – into the economy to prop up an economy that was in many ways shut down.”

Hochholzer said there are varying opinions on the stimulus. 

“Did they maybe go a version or two too far, you could maybe have that argument,” he said, “but for the most part… it was the right thing to do at the time.”

Rasoul Rezvanian, associate dean of the Cofrin School of Business at the University of Wisconsin-Green Bay, said putting more money in the hands of people had some impact on today’s financial crisis.

“Overspending took place with no origin in a short period of time,” he said.

However, Rezvanian said he believes mistakes the Federal Reserve made in the past two to three years also contributed to the financial crisis.
“The Federal Reserve has kept the interest rate very low for a long period of time,” he said. “It is human nature that when things are good, we never think about a rainy day. That’s exactly what happened. Things were good, everybody was happy and interest rates were low. So they kept it low for a long period of time.”

Hochholzer said that produced an enormous amount of stimulus and created an environment where investors couldn’t earn a return in bank deposits, lower-risk, fixed-income securities.

//s3.amazonaws.com/appforest_uf/f1666206471361x870397096460922500/richtext_content.pngMike Hochholzer said there needs to be a clear distinction between the financial markets and the economy. Stock Photo

“The acronym became TINA – meaning there is no alternative: T-I-N-A,” he said. “So, that forced investors toward the stock market increasingly, pushing valuations higher.”

Now, Rezvanian said they are making the same mistake in the other direction.

“They are raising interest rates faster than what they should do, and that impacts the financial market,” he said.

Hochholzer said the faster-than-expected bounce back the world saw during the pandemic due to the quickness of a vaccine was another contributing factor to the state of things now.

“(When we) shut most of the global economy down and businesses (that were) making plans for production and building new facilities and all sorts of things all went, ‘Whoa, wait a minute, this is not the time to be doing those things,’” he said. “Vaccines came along, and we turned the corner incredibly quickly.”

But what that did, Hochholzer said, was set up a V-shaped recovery.

“We had shut everything down, and then we were like ‘Oh, geez, we can go pretty quickly back to normal,’” he said. “And all of those production plans, the ordering of all sorts of things just couldn’t turn the corner as fast as that did, which set us up for all these supply chain disruptions. And shortages is maybe a strong word, but constraints in terms of availability of stuff.”

To a certain extent, Hochholzer said even labor could be included in that.

“That very rapid turn, also as a result of the pandemic, a somewhat different version of a result, but definitely a result of the pandemic, set us up for the circumstance that we’re faced with right now,” he said.

Hochholzer said the interest rate and inflation also ratcheted up far more quickly than most of the world expected.

“The huge amounts of stimulus, both fiscal and monetary, plus the disruption to the normal growth and movement of the production and delivery of goods, set us up for a circumstance where we have an inflation problem at this point,” he said. “And then kind of on the back end of that, compounding it, you also have the Fed now admitting they were slow to react.”

Hochholzer said by being slow to react, “the fire got hotter before the fire department showed up.”

“And that just means it’s going to take longer to put the fire out,” he said.

Differing impacts
Hochholzer said when a recession hits, it impacts everyone differently.

“This environment, while on the whole, is clearly a negative – rising rates, rising inflation,” he said. “That being said, it impacts different people and different businesses in different ways.”

Hochholzer said it’s twofold.

“No. 1 – it’s not necessarily all bad,” he said. “There are some benefits to higher interest rates, depending on your financial position. And No. 2, the impacts can be incredibly varied. The unfortunate and difficult part of it is, it hits those at the lower end of the income spectrum, a whole lot harder.”

Political influence
Hochholzer said there needs to be a clear distinction between the financial markets and the economy.

“Elections affect policy,” he said. “The history is very clear that… elections have little to no impact on the financial markets. From our perspective as portfolio managers, we don’t drive decisions off of election.”

From an economic perspective, Hochholzer said maybe there’s a little more influence.

“There are some things that particularly the White House can have at least an impact on on the edges,” he said. “Again, longer term, we don’t see it as a key driving effect. Capitalism wins.”

Hochholzer said to a certain extent, the economy likes a bit of gridlock in Washington.

“If you’ve got different parties in the House or the Senate or the White House, the fact that very little gets done, and the rules are, what the rules are, is actually a pretty good situation for the economy as well as the markets.”

Hochholzer said business, for the most part, just wants a clear set of rules.

“As long as the rules were fairly consistent over a relatively long period of time, businesses found a way to work within those rules,” he said. “So, we don’t spend a whole lot of time focusing on elections and what the outcomes there are likely to be.”

Deppiesse said elections become more of a talking point during presidential than midterm election years.

“The closer you get to the election, some people will decide that they’re gonna wait and see what happens,” he said. “But the reality is, typically, the one person changing office or staying in office doesn’t overnight change every policy. It takes some time for those things to work their way through… And then whatever actually gets passed a lot of times is way different than that or never gets passed.”

Is this a recession?
Rezvanian said whether or not we are in a recession depends on how one defines a recession.

“Textbooks will say if you have a certain percentage of decline in your GDP (gross domestic product) for two quarters, that is the definition of recession,” he said. “We are not there yet. By definition, we are not in recession, but practically, we are in recession.”

Rasoul Rezvanian

Hochholzer said the Fed has made it as clear as they can — they are in this to end the inflation issue as we see it today.

“That’s one where, I believe, you have to take them at their word that they are going to continue raising rates until this inflation problem at least starts to roll over and at some level comes under control,” he said.

Hochholzer said the question the market is grappling with at this point is, does that mean there has to be a recession?

“At least our current view and predictions, we’re not committed to this, but our likely outcome here is that it probably does generate some sort of a recession in 2023,” he said.

Hochholzer said looking back through history, anytime rates have gone up this fast, this quickly, the outcome has been a recession.

“It’s hard to imagine this one is the exception to that rule,” he said. “Again, maybe because of the fact we got here in a very unusual way, maybe you get an unusual outcome as well. I don’t know. If you said what’s your forecast, a recession in 2023 would be that forecast.”

However, Hochholzer said based on a solid banking system, solid consumer and good jobs market – “We would look for that recession to be relatively shallow and relatively short.”

Rezvanian said there is no way to not have a recession in the very near future, but it’s what the degree of that recession will be that’s important.

“It’s not if we will have a recession or not, yes, we will have a recession,” he said. “What is important is what the degree of recession will be and how long is it going to last?”

Deppiesse said at some point, the rate-raising cycle will end and then at some point the economy will start to grow again and the market will go back up.

“Now, how long does it take between now and then, who knows?” he said.

Deppiesse said we’re probably in a technical recession right now.

“I haven’t really seen it in my day-to-day job,” he said. “Some people are seeing slight slowing. We typically see it slower or later in the Midwest, just as we typically see the pickup later in the Midwest than they do out on the coast. So far, whether it’s financial statements or just sentiment from the business owners I talked to, I’m not seeing that there’s been any significant slowdown occurring that has people concerned. But it’s kind of, you always need to be prepared.”

Hochholzer said at this point, from a business front he also isn’t seeing any significant slowdown.

“Could it be coming? Yeah,” he said. “The rising interest rates are perhaps going to put a damper on people’s willingness or ability to borrow to expand or to start a new business or whatever. But to this point, I don’t think we’ve seen a lot of that happening on the business front.”

Hochholzer said the best anybody can genuinely do is to think about a range of scenarios.

“You need to understand that making a prediction is a fool’s errand and to get it right is impossible, at best,” he said.
Hochholzer said the best approach is to consider outcome possibilities.?

“What’s the sort of base case?” he said. “What if things are better than that? What would better than that look like? What if things are worse than that, and what does that mean?”