On-Demand: An Economic Update in Turbulent Times
- Jun 24, 2022
Chief Economist at JLL discusses how the pandemic, political policies and the invasion of Ukraine have contributed to a host of global economic issues.
Travis Epp: Thank you, Bella, and thank you everyone for joining us this afternoon to discuss an economic update in turbulent times. As Bella indicated, my name is Travis Epp and I'm in charge of the industry growth for EisnerAmper's manufacturing and distribution practice.
I also had the extreme honor of introducing our guest, Ryan Severino, Chief Economist of JLL, a fortune 500 global real estate firm, who will make a wonderful presentation to us this afternoon. Free bio on Ryan. Again, he's a Chief Economist where he manages the economics team and is responsible for the global and regional economic research analysis and forecasting as well as the prompting market forecasting. Prior to JLL, Ryan worked at Moody's and he also worked at Starwood Capital Group and Prudential Real Estate Investors.
Additionally, Ryan is adjunct professor of real estate finance and economics at Columbia University in New York. Ryan also holds a master's degree from Columbia, a bachelor's degree from Georgetown University, and is a CFA charter holder. Also, having had the opportunity to get to know Ryan over the last number of months, he's probably the coolest economist you'll ever meet. And with that, I'd like to throw it over to Ryan. Again, Ryan, thank you for joining us today.
Ryan Severino: Thanks, Travis. And thanks for that introduction. Thanks, everyone, for joining us today. I always find it interesting to talk about the economy, but certainly we are in interesting times. And I thought it would be a good idea to hit on some very important things that I am encountering a lot these days when I'm speaking to clients, audiences, especially in the realm of their concerns. I thought we would start with the elephant in the room, inflation. Inflation is dominating the conversation today. It's almost impossible to avoid it anywhere you go. And I thought it would be a good place to start our discussion. I want to discuss the impact that inflation is or is not having on the economy and how I think the powers that be including central banks like the Fed are going to respond to it. Then I want to focus on commercial real estate a little bit, but specifically the industrial market and logistics and how that's playing into this narrative that's occurring around us. And then lastly, you really don't need me to discuss risks and surprises with you after the last two years, but I thought it would be a good way to conclude our discussion today with a bit of a wrap up on that.
So I want to start with inflation. Where's it coming from and how is it actually showing up in the economy? I'm going to start very big picture, fundamental economics with the supply side of the economy. And I think everyone has heard about the supply chain disruption that we are contending with right now. This is the easiest most straightforward way that I can demonstrate that to you. What I'm showing you on this slide is an index that has been produced by the New York Federal Reserve. And it's designed to capture a lot of disparate factors in one easy to understand metrics. So the only thing you need to understand when you look at this slide is that if the red line is higher, it means the supply chain is more disrupted. If it is lower, it means it is less disrupted. And I labeled a few points on the slide to give you some context just what this means relative to the recent past.
You can clearly see the COVID pandemic looks like a tsunami versus other periods of disruption in the economy, which look more like gentle breakers cresting in. So that's the bad news. The bad news is this pandemic has certainly disrupted production and the supply side of the economy. The good news is if you look over on the right, it does seem tentatively like that red line is starting to trend down and other metrics in the economy support this idea. Things like shipping costs, deliveries of semiconductors, even autos. You're starting to see some nascent signs of improvement there. So fingers crossed, but maybe not holding our breath on this. The supply side certainly has been disrupted, but maybe there's finally a light at the end of the tunnel in terms of supply disruption.
On the other side of the economy is demand. And we knew that demand was going to come roaring back after the last couple of years. A lot of the consumption that would've normally occurred in 2020, in 2021 that didn't because of the pandemic, some of that is being reallocated to subsequent periods like this year, next year. But the other thing that happened, and I say this as a very apolitical person, in addition to this resurgence of pent-up demand being unleashed, the Federal Government came out and spent unprecedented levels, aggregated to about six trillion dollars. And I call this my twin peak slide because you could see the points in time where the government spent aggressively. Early in 2020, early stages of the pandemic, and then in the first quarter, last year when we had the most recent round of fiscal stimulus.
Basically, we took a resurgent demand and we turbocharged it a little bit by adding government stimulus on top of that. And that brings us to a point where I'm not wholly surprised to see inflation. Supply is growing, but struggling to keep up because of the pandemic really morphing, and evolving, and shutting down production continually. And at the same time, demand has grown considerably. But beyond that, there are two more things that I want to highlight. First is that, since the pandemic, we have seen a very notable shift in the composition of spending on the part of consumers in the economy. And what I mean by that is since the pandemic, we have shifted more towards consuming goods and away from consuming services, which makes sense. We can relatively safely, relatively, consume goods at home whereas we have to consume services for the most part somewhere else. And that's a little more precarious.
If you're going to consume services at a bar, or a restaurant, or a disco tech, or whatever the cool kids are doing these days, well, then you generally have to be around other people, which is potentially a little more dangerous. And you could see that has stuck pretty well since the onset of the pandemic. I highlight that because this is exacerbating the supply chain disruption that we were just discussing a couple slides ago. What I mean by that is, let's say for argument's sake, your favorite restaurant is closed. You can go to your second favorite restaurant, or your third favorite restaurant, or your 47,000th favorite restaurant. But if production of a certain good in our globalized, specialized economy is concentrated in one or two parts of the world and production of that thing gets shut down, well, there isn't a plan B, or C, or D, or E. And that is a lot of what we have faced over the last couple of years and it is exacerbating the inflation that we are already feeling.
There's one other thing going on that is clearly worth discussing and that's the situation in Eastern Europe. And not from a political point of view, but what I would say from an economics point of view is that this is also exacerbating inflation because as I think people are well aware, that part of the world is very important to global energy and global food production. And the way that I see that manifesting in the data is if I look at the difference between headline inflation, which includes all goods in services that we consume in the economy versus core inflation, which backs out things like food and energy because ... Not because people don't eat or consume energy. I always love when people level that accusation as economists. It's not that we don't think that's the case, but they tend to be pretty volatile. But in a moment like this that is clearly exacerbating what's occurring, you could see that is causing that headline inflation to really run ahead, even though core inflation is, as I'll show you a little later, tentatively seems like it might be stabilizing and finally trending down.
The box that I've superimposed on this slide is really the period from which the war broke out in late February to where we are today. And you could see that kicked that difference between headline and core inflation into a higher gear. And that's because we have seen significant pricing pressures on energy and energy-related products and food and food-related products since that occurred. And it is causing that upside surprise that we noted in inflation last month is really predominantly coming from food and energy because of, to a large extent, the situation in Eastern Europe. And then if I'm being honest to a lesser extent, we are also dealing with a refinery capacity shortage in the United States as well.
But this is I think in a lot of people's minds, this is what, as I'll show you, makes them uncomfortable, this is what they don't like about inflation right now. And unfortunately in the short run, this rift is getting wider, not narrower. What does that practically mean for us? Well, when I think about inflation and I try to break it down, I try to peer through some of the short-term disruption to get to more of the underlying dynamics that central banks like the Fed are trying to peer at. So let's do that a little bit. If I take the most recent headline reading, year over year reading for inflation in the economy in May, it was about eight and a half percent. If I back out those components of headline inflation that are really volatile and disruptive, like energy and like food and I get to the core figure, it gets me to about 6% on a year over year basis.
The last thing I want to back out of this is that fiscal stimulus because ... Again, I'm not a political person, but I think it's fair to say that the appetite to keep spending like that when inflation is already running at eight and a half percent, you're not going to find that across the political spectrum these days. Let's back that out of the equation as well. And that gets us to this metric that I'm calling core CPI, core inflation, less fiscal stimulus. And that's about 3%. Now, that is still above the Feds target of about two to two and a half percent. But this is akin to what the Fed is trying to do right now. The Fed is trying to see through these temporary or idiosyncratic factors through to the underlying dynamic. And from the Fed's point of view, they see this and they think, "Maybe in the long run we get back there, but that's still probably a little too uncomfortable for us at the current juncture. We need to figure out how we can work on bringing this down in a more managed fashion." And that's really where I want to take the discussion next.
How is this actually impacting or not impacting us in the economy and how I think the Fed is going to try to address it and really try to bring about some deceleration in inflation over the next, say 12 to 24 months? I want to start with this slide. And this has become one of my favorites. And I call it, watch what consumers do, not what they say. Because if you've been paying attention, the consumer sentiment index, which is produced by the University of Michigan in early June, recently hit the lowest level on record. And if you didn't know anything about the economic environment, you might think, "Wow, it must be terrible if consumers are feeling the worst that they've felt since they started conducting this survey 60, 70 years ago." Yet I would argue that the underlying data is somewhat incongruous or at least inconsistent with that negative of feelings on the part of consumers.
I say that because if I contrast that with retail sales, which is the black line on this slide, retail sales are still at or near record high levels despite consumers feeling so doer about things. And that's why I focus on what consumers are actually doing with their money and not so much what they're telling surveyors because it's very easy to feel negative about inflation, especially in an environment where the supply chain is a little disrupted and you might not be able to get the exact thing that you want or in as timely a manner that you want and you have to pay more for it in the process. Yeah. That is not going to make people feel tremendously happy, but it's not actually dissuading anybody's behavior. That of course raises the important question, how are consumers able to accomplish this?
Well, the first thing I want to show you in order to address that is a metric that I call aggregate earnings growth. You might hear some other economists call this aggregate payrolls. This is a proxy for the overall spending power of consumers in the economy. It's a function of three things. It's a function of how many people are working, how many hours per week on average are they working, and what the average hourly wage is? And if you multiply those things together, number of people times number of hours times average wage, you get a proxy for overall spending. And if I compare the growth rate of that on a year, over year basis to that headline inflation figure I was discussing earlier, you could see that really since the initial stages of the pandemic, that difference has been positive. And this is how despite the fact that wages are growing more slowly than inflation, we as consumers have been able to keep powering the economy.
I think the average person probably doesn't appreciate how powerful three, four, 500,000 net new jobs per month is. That's not normal. This has been an incredibly fast labor market recovery, the fastest since the SNL crisis of the early nineties. As we keep putting more people to work, that is a lot more spending firepower that we can unleash into the economy. People who get jobs they might rent apartments, they might need new clothing, they might need a new car. They certainly have to spend on transportation even if they're not going into an office or workplace every day. That is an incredible, incredible motivator for consumers to go out and spend both in a non-discretionary manner and a discretionary manner. And that's been really helpful for us as we've really tried to push ahead. But the problem with this is that the labor market has become so strong that in a sense we've kind of become public enemy number one.
Let me show you what I mean by that. Because as the Fed is looking at the environment and they are trying to address what they can, I mean the Fed ... I think it's fair to say has been charged with doing more things than it was originally intended or it was originally chartered to do. The Fed is not really, or wasn't at least, designed to be economic superheroes, fixing all of the problems in the economy. That's a bit what they've become these days, but their ability to manage the economy is still limited relative to what they're often charged with. The main thing that they can do is they can manipulate the financial side of the economy. They can manipulate interest rates, they can manipulate money supply, to a lesser extent they can manipulate banking regulation.
So if you are the Fed and you have a hammer and it's the only tool that you have, well, then you go around looking for nails to hammer down if that's the only tool that you have in your toolbox. And what I mean by that is from the Fed's point of view, they can't do a lot about the supply side of the economy that we were discussing earlier. They can't do anything about energy production, they can't do anything about food production, they can't really manipulate that part of the economy, but through the manipulation of interest rates and monetary policy, they see themselves as able to manipulate demand. So they think if supply is not keeping up with demand, then they can bring demand down to try to bring those two things back into a better equilibrium. And this is why I say labor has become public enemy number one because the Fed looks at demand in the economy and they see excess demand. And this is the best way that I can demonstrate that to you.
What I did on this slide is I took the level of employment in the US economy and the number of open jobs in the US economy and I effectively indexed them at the beginning of 2020 so I could make an apples to apples comparison. So the only thing that you really need to pay attention to when you look at this slide is how those two lines fare relative to each other and then relative to the dash line because I want you to think of that dash line as break-even relative to the beginning of 2020 before the pandemic.
So if you follow the black line, which is employment, you could see we lost some jobs with the onset of the pandemic and then we've done a pretty good job, as I said, no pun intended, of gaining them back to the point where now employment is more or less break-even in the economy relative to pre-pandemic levels. But look where the number of open jobs has gone. Even though employment is more or less back to break-even, the number of open jobs now sits about 60% higher than it was pre-pandemic. There are right now about 11.4 million open, but unfilled jobs in the economy. Organizations are trying to fill 11 and a half million jobs and they're struggling to do that. And the Fed sees this excess demand for labor and thinks, "That's where we can go after. That is a part of the economy we can target. We can bring down demand for labor and we can start to cool some things off." But I'll tell you, I'm a little bit dubious about this and let me show you why. And it goes back to something that we were discussing earlier, but I want to expound on it.
It's this difference between the headline inflation, which is being driven, again, largely by energy and food and the underlying core inflation, which is mostly driven by everything else that we purchase as consumers. And if you look at the box that I have superimposed on the graph over on the right, which is the last few months of data, you see something interesting or at least I think it's interesting. You see that headline inflation has stayed elevated. Again, we had that surprise reading last month because of the situation in Eastern Europe exacerbating things. But if you actually look at that underlying core inflation and wage growth, they're both decelerating on a year over year basis over the last few months. I showed it to you in another measurement system. If I showed it to you say on an annualized growth basis, it would look even more pronounced than this slide. But the point I'm making with this is I wonder about the Fed's ability to actually target inflation or at least the inflation that is really causing problems right now because again, it seems like underlying inflation and wage growth are already decelerating even though headline inflation is staying at fairly elevated levels.
I'm a little bit concerned with the Fed's ability to actually go out and target what it thinks it can target. As I will show you shortly, I'm not panicking about this, but I do think it's going to be difficult objectively for the Fed to target headline inflation because components like food and energy are just beyond their domain. Now, they can certainly bring down other components of inflation, including wage growth if they decide to go after that by siphoning that excess demand out of the labor market, but we're going have to keep an eye on this because they might ultimately be able to bring inflation down, but it is not going to be an easy slog in order to do that.
How are they going to do that? Well, they're going to raise rates. That's what the Fed does. Again, this is their hammer and they go around looking for nails. There's some good news and bad news about this. So the good news is I think the Fed is going to be relatively constrained in their ability to raise rates even though inflation is running hot. So what do I mean by that? I mean that the Fed is going to try to push as hard as they can without causing a downturn. The Fed knows that they can raise rates, or at least they think, we'll get to that in a minute, they think they can raise rates and tamp down inflation a little bit, but they know that they can't go too far because if they do that is the classic recipe for a plain vanilla post-war recession in the United States.
If the Fed raises rates too much and they overshoot, they will almost certainly cause a downturn and the market will not be shy about telling them that they have gone too far, much like they did last cycle. So even though you could see in my forecast, both at the short end of the curve, the three month treasury yield and the long end of the curve, the 10 treasury yield, my model at least thinks that the Fed can push a bit beyond where we got last cycle because inflation is certainly running hotter than it was. The model thinks it's going to have a hard time pushing beyond that without causing a downturn. And again, I think if nothing else like last cycle, the treasury market will clearly signal to the Fed that they think they've gone too far. And that will hopefully give the Fed some ability to say, "Maybe we should ease off of this a little bit." And I say that not just because it's happened the last cycle, but I think this Fed is acutely aware of the risks that they face both in terms of the inflation side and then certainly in terms of what could potentially happen if they push too far. But let me show you why I'm a little bit dubious about what the Fed can do, especially as it pertains to core inflation and wage growth.
I went back and I looked at the last four tightening cycles by the Fed in the US. Call it just round number the last 30 years. And what I was looking for is I was looking for a trend in the data that basically said, "As the Fed starts tightening, there's a clear downward trend in the core inflation measure that they like to utilize." And I just don't see that when I look at the data. I see randomness because if there were a pattern here, then in each of these four graphs on the left side inflation would be ... It would vary, but it would be at higher levels. And then by the end of their tightening cycle, it would still vary, but it would be at consistently lower levels. I just don't see that when I look at this data. I see somebody's bad EKG, or a seismograph, or something like that. It's far too idiosyncratic for there to be a trend. So I worry a little bit that maybe the Fed, maybe they might be able to bring down some headline inflation, but I do worry in their ability to actually target core inflation, especially in an environment where inflation might be decelerating to begin with.
So we'll have to keep an eye on this to see if the Fed is going to be successful. But the other part of this that I won't say I worry about, but I think about is should we actually fear higher inflation? I know people don't like it. I know it makes us unhappy. There's really good empirical research going back decades that says that. But if you actually look for empirical evidence that inflation is detrimental to economic growth that imposes a serious cost on the economy, you are going to struggle to find strong evidence of that. There's excellent, excellent, excellent empirical evidence by hardcore academic economists that says, "Unless inflation gets to really elevated levels ..." And when I say really elevated levels, I'm talking Weimar Republic, Germany in the 1920s, Zimbabwe under Mugabi, or Venezuela under Maduro, or the Argentinian default back in the beginning of this century, the beginning of this millennium. If you exclude those periods, you don't ... those particular episodes, you don't see a lot of empirical evidence that says inflation is detrimental to economic growth. This slide is my very humble contribution to that pool of research.
I simply created a scatter plot and I looked at growth in the economy on a calendar year basis against inflation and I lagged it by one year because there's this ... Usually when I bring up this topic in discussion, somebody says, "Well, it takes some time for everyone to adjust their expectations and moderate their spending. Maybe look at it on a lag basis." I said, "Fine. I don't have any problem looking on a lag basis." Even when I lag this one year, I do not see a strong relationship between those two things. That does not look like anything approximating a linear relationship because if there were a linear relationship, you would see a downward sloping line. It would actually slope kind of down to the left, which would say when inflation is higher growth would be lower. But I don't see that. I see something that just looks like a very scattershot approach to making a graph. In fact, if any of my econometric students handed this in as evidence of a tight relationship, I would hand it back to them and say, "Find a tighter relationship." Because it's just not a very good, meaningful relationship.
The one other pushback on this that I get when I bring this up is somebody will say, "Well, what about higher levels of inflation in the US? What do you see there?" And I say, "Okay. Let's take a look at that." So if you look at the box that I've superimposed on the slide, that's any period where on a calendar year basis inflation was running at call it about 8% or above. And even within that realm of high inflation, I don't really see a meaningful relationship between these two variables. If anything, that's probably pretty close to a flat line because you'll have some periods where inflation's high and growth is weak and periods where inflation is high and growth is strong. So I am cautious about the idea that inflation is damaging.
Now, that raises a really important question. If that's the case, then why is the Fed so concerned about it? The reason for that is, at least from my point of view, is the risk that if people are so concerned about inflation in our modern news ecosystem where we hear about it over, and over, and over, and over and it is virtually inescapable, the risk then becomes that this turns into a self-fulfilling prophecy. That at some point, think back to that really record low negative consumer sentiment reading I was discussing a bit earlier. If that sentiment actually starts to impact behaviors of consumers, of organizations that typically spend money, then it could very well become a self-fulfilling prophecy. Because if we tell ourselves a narrative that says the future is going to be worse, well, then it's very easy for us to think maybe we should back off spending, maybe we don't need to go on vacation, maybe we don't need new furniture, maybe we don't need to refurbish our basement this year, whatever the case happens to be. And not just individual consumers. Organizations themselves, businesses can say, "Well, maybe we don't need to hire as many people. Maybe we don't need to invest in research and development or intellectual property products." Whatever the case happens to be, they might back away from those things. And that very well could become that kind of negative self-fulfilling prophecy.
So it's not so much that I think inflation in and of itself. It's really this economy destroying juggernaut. I think it's a little more the monster that might or might not be in your closet, but I do think there's a legitimate concern that if this festers for too long, it could ultimately start to manifest itself in a much more meaningful and pronounced way if people change their behaviors and it translates into slower growth, if not an actual downturn. And that's where I think the Fed has to be a little cautious about this.
So where does the rubber meet the road on this? I want to start with inflation as I think about equilibrium in the economy because this is clearly the part of it that I think everyone is concerned with. And I've been calling this, for those of you who are familiar with the show, my family feud slide. The top 11 answers are on the board. And I say that because the first four reasons for why I think inflation should peak this year and start to back off are kind of demand side factors. The second four, 5 through 8, are more supply side factors, and the last three, 9 through 11, are more technical or mathematical factors. I think rather than me getting hung up on whether my forecast is going to be correct down to the basis point because you could see I'm already using interval forecast as opposed to point forecast because it's ... Inflation is such a difficult thing to predict, but what I'm mostly concerned with is the shape of this graph. And to me, the shape of this graph feels correct. And of those 11 points that I put on the slide in favor of why inflation should peak and back off, I want to focus on number 10. Inflation is spiky. And admittedly, that is maybe not the most technical economics term, but it is spiky.
What I mean by that is if you look at inflation on a calendar year basis, it tends to run up quickly and then start to come back down relatively quickly. It doesn't mean it immediately gets back to pre-acceleration levels, but it means that it doesn't stay elevated for a prolonged period of time. Even if you go back to the 1970s with the geopolitical events that exacerbated oil prices in the early 1970s and the late 1970s, you don't see inflation look like a plateau. It doesn't run up, stay elevated, and then come down after a prolonged period of time. Like I said, it looks spiky. It looks more like mountains. Again, even in the 1970s, you will see a spike up in the 1970s and it starts to come down. And then before it fully settles back down to kind of pre-disruption levels, there's another geopolitical event that causes it to spike up again and then it starts to come down.
Therefore, when I look at the shape of this graph, I'm not so much going to lose sleep over the specific forecast. I'm generally concerned with that overall trajectory, which looks maybe not spikey the way that it did in the 1970s, but it's got that kind of spike like shape to it. It's not a plateau where inflation runs up last year into this year, stays at an elevated level for a number of years and then starts to come down. And to be fair, I will tell you objectively of the economic prognosticators that are out there. I do not even have the most aggressive forecast on this. I won't name any names, but I will simply say a number of clients have recently mentioned that there are more aggressive forecasters out there, meaning they see inflation decelerating even faster than I do. I don't think that's going to be the case. I think that we're going to see some things sticking around, especially when you think about the fact that we have 11 and a half million open, but unfilled jobs in the United States right now because we have a very pronounced labor shortage.
As a consequence of that, I think it's going to be difficult to get back to the pre-pandemic average level of inflation, which is that dash line that I've superimposed on the graph. But I do think inflation can back off relative to where we've seen it over the last few quarters, but I would strongly caution that this is not going to be a panacea. It's not like flipping a switch. It's going to take some time for it to decelerate. As I tell my older daughter all the time, we live in a world of probability, not a world of certainty. I think it's much more probable that inflation decelerates in the coming periods than it stays consistent at high levels in the coming periods. That said, if you take umbrage with that, if you want to argue against that, what I would say is you have to pick at least some of those 11 factors over in that box that you disagree with and you have to believe that will overwhelm the other factors on the slide.
So, I'm not telling you what to think about this because there are very strong opinions on inflation these days. I'm simply saying, if you are going to argue against this kind of spiky trajectory and for something that looks more like a plateau, then you have to take issue with some of those factors, some combination of those factors and think whatever part of that argument you disagree with, you think that it more than makes up for the other factors that I'm citing on the slide.
The other part of the good news is not just that I think inflation will start to moderate over time, but I think economic growth is still pretty solid. And full disclosure, I might have to revise this down a little bit when I rerun the model, but I'm still cautiously optimistic. This slide is the output of my scenario forecast model. Because again, we live in a world of probability, not a world of certainty. And I'm not showing it to you because I want to extol the virtues of my super awesome scenario forecasting capability so much as I just want to highlight the fact that at least through the end of next year, even in the model's downside scenario, the model doesn't think that we're headed for a recession. And I'll tell you even beyond the period that I'm showing you, the model is not yet forecasting a recession. I do not think it is inevitable. I do not think it is a foregone conclusion. I realize that increasingly I'm becoming in the minority on this as more and more economists out there tend to think that it is going to become inevitable, but I just don't see that.
Again, the labor market is strong, consumer spending is strong, wage growth is healthy. I still think there's enough momentum for now to carry us. Again, it's a probabilistic world, so that could certainly change. But as I sit here in June of 2022 at not just my point of view, but even just a cold dispassionate model doesn't yet see a recession as an inevitability. I'll concede that the crystal ball gets murkier beyond the end of next year, '24, '25, '26. But again, as I sit here today, I do not think it is a foregone conclusion. I do not think it is inevitable. I think growth certainly decelerates partially because of higher rates and partially because of the supply chain starting to ease up a little bit, demands starting to back off, but I don't think that we're inevitably headed for a downturn.
I want to switch gears a little bit and talk about commercial real estate broadly, but then particularly what it really means for industrial logistics. This slide is what I've been calling my cycle scorecard. And I created this slide to answer the question, where are we in the commercial real estate cycle? And I created it in the summer of 2020 because I was getting asked the question, how long does it take after the economy stops contracting for commercial real estate to stabilize? And I'm using vacancy rates as my metric of stabilization. So, we all know there's a lag. The economy bottoms out, there's a bit of a lag, vacancy stabilizes sometime after that, vacancy stops rising, and then demand starts to grow faster, then supply and vacancy comes back down. I said, "Okay. There's two ways I could approach that." I went back and I looked at history and I wanted to see how long after that economic bottom it took vacancy rates, nationally in the US, to stop rising. So that's that column that says, "On average, vacancy rate lags." For office and industrial, it's about eight quarters. For retail and apartment, it's about five quarters. I said, "Great. Now I've got a benchmark." Because I know the economic bottom was the middle of 2020.
So, I took that economic bottom, it's the same for all property types, I added the average for each of the major property types and I got to that history projected time of peak. History suggests that office and industrial should hit peak vacancy in '22, retail and apartment should hit peak vacancy in '21. Then I used that scenario of forecasting model I was talking about and I ran the model and I said, "What does the model say in the base case relative to history?" And the model lines up pretty well until you get to industrial where the model says, at least in the summer of 2020, it said we are going to hit peak vacancy this year. We might even be past it and we're off and running again. If you think back to the summer of 2020, we're still in the pandemic so the first time I showed this to someone, I was doing the presentation online similar to this, and I showed someone that forecast and they were just ... they found it so impossible that they felt compelled to come off mute and interrupt me and criticize it. And then they said, "Where did you learn to forecast anyway?" And I thought, "Boy you know, in a public form if you were going to throw down the gauntlet like that, I am going to pick it up and I am going to smack you with it."
So I honestly answered their rhetorical question and I said, "Columbia University. It's in New York City. Have you heard of it?" And then everybody chuckled and he felt a little sheepish, but I emphasized this because the model was pretty much spot on about that. It called that revolution in industrial two years outperforming historical guidance. And that raises some interesting questions. Why has that been the case? Well, let me show you how it's actually manifesting itself since then and then I'll talk about why it's been the case. So you could see if you look at our empirical data, the model was spot on with that. National vacancy peaked in 2020 and it has come down fairly consistently since then. And we are now basically at record low levels. We are seeing such strong demand from people shopping at home. From people, as I mentioned earlier, not leaving their house as much. The manufacturing sector of the economy has actually come bouncing back a bit now that we're seeing companies think a little bit about reassuring and nearshoring because they don't want to be so dependent on supply chains that are linked to production in only one part of the economy, global economy on the other side of the world. We have seen all of those things really come roaring back. And so demand in the economy has been incredibly strong over the last couple of years.
It's starting to ease a little bit, but certainly relative to pre-pandemic levels, we are seeing incredibly strong demand on the part of tenants. And in particular, if I drill down on that a little bit and answer the question, well, what kind of demand are we're seeing? Not surprisingly, a lot of it is coming from logistics companies who are responsible for moving goods around the world. If you look at this slide, you could see some of the greatest demand is coming from people. Not traditional retailers or eCommerce, but a lot of organizations responsible for that. The FedExes of the world, the DHLs of the world, the XPOs of the world, the postal service, UPS, Saddle Creek.
It's not surprising to me when I look at this slide to see the composition of demand so strongly constituted by organizations like that because of the world that we now find ourselves in. Whether or not this persists on a permanent basis, I think is ... the jury is still out on that a little bit, but certainly for the foreseeable future in the world that we live in, as we start to think through the longer term ramifications of what this pandemic means, not just for the economy, but for commercial real estate and in particular industrial commercial real estate, I think they are going to be outsized important players. And even through the first quarter, if we want to argue that, maybe it seems like into second quarter, demand is backing off a little bit. I don't see it backing off enough that I think that this narrative is going to be materially different as I try to peer into the crystal ball and I think about this market 12, 24, 36 months down the road.
Just switching gears one last time, risks and surprises. Again, you probably don't need refresher on risks and surprises, but I do want to highlight some of the important ones as I think about the global economy and the domestic economy. The situation in China is pretty, I will just objectively say, interesting. Not just lockdowns associated with the pandemic, but you've probably heard they're going through a very serious issue now with their real estate market, which has been over leveraged in a way that we have certainly grappled with in the United States and other developed countries over the last couple of decades. And beyond that, you're now starting to see targeting of the technology industry in China in a way that we haven't really seen.
I emphasize that and admittedly estimates vary with Chinese data, but if we take the real estate industry and the technology industry and we combine them together, we are probably looking at somewhere about ... I will give you a rough range because of the quality of the data and say 30 to 40% of China's economy is probably constituted by real estate and technology. So if both of those industries run into trouble either because of mistakes they've made in the past or mistakes that might be made in the future that could be precarious for both the global economy and the US economy. I love showing that image center top for the labor shortage, especially the sign that is literally anyone, although we're begging and please still hiring are also nice. We still have a very pronounced labor shortage. It is demographically-driven. It is not a function of the pandemic. So it's going to stick around for a while. We're going to have to contend with that. Good news for us in the labor market, but maybe not so great news if we're hiring.
I'm not a political person, but we do have an election this year and another one in two years. If the last one was any sort of benchmark to go by, I will just euphemistically say, buckle your seat belts. It might get a little bumpy. If I shift to the bottom, inflation ... Again, I think I have a sense of where inflation is going, but it has certainly been surprising on the upside. So I want to at least acknowledge that it continues to be a disruptive force and we're sort of dealing with a little bit of unknown factors like the pandemic. It brings me to the next image on the slide, thinking about Eastern Europe.
Again, I'm not a political scientist or a military strategist. So I don't have a good sense of exactly where that's going. That could certainly contribute to inflation as this process runs along. And then lastly, the pandemic is still with us, whether we want it to be whether we don't want it to be. It's hopefully evolving and becoming less disruptive, but I was just reading an article in The New England Journal of Medicine yesterday morning because I'm an Uber geek and I do that sort of thing. And they were talking about how some of these new variants can very, very efficiently, if not completely, evade both vaccination antibodies and prior infection antibodies. I don't know what that means for the future, but I wasn't thrilled to read that when I did. So let's just acknowledge that the pandemic is not over yet. It's still with us and we have to grapple with it.
So just quickly to wrap up, I like to do the so what at the end because it's one thing for me to give you a moderately interesting and entertaining tour around the economy. What does it mean for us? This is how I think about this. What's the problem? The problem is that inflation stems from many sources, its impact remains maybe unclear at best if not actually minimal, but it could manifest itself into a bigger issue down the road. What's the solution? Well, again, if you're the Fed and you have that hammer, the solution is to tamped down inflation by raising rates potentially empowering the rest of the economy.
I wonder a little bit if the solution isn't potentially more dangerous than the actual problem it's trying to solve. And then lastly, I think industrial remains the darling of commercial real estate. It's driven by e-commerce certainly going back to that slide I showed toward the beginning of the presentation, but boy, logistics, and supply chains, and even the resurgence of manufacturing have really pushed industrial into the cat bird seat as we sit here in 2022. And if you are even remotely involved or deal with the industrial market, it is at a pretty good place to play these days, which is maybe the easiest way that I can say that. So with that, I am going to shut up and conclude my remarks, but we are going to take some questions for the balance of the time. Thanks very much.
Travis Epp: Ryan, thank you very much. You definitely gave us a lot of information. We received some questions in advance of the seminar when people registered and we also have some questions online that we will try and get to. One area that I'd like to address to begin with is consumer spending in a couple parts. So with inflation is one of the reason that retail sales are up is because of inflation. How is this really impacting people on maybe the bottom end of the economic spend spectrum? And then how are these purchases being financed? Whether it's the balance sheeters that have more use of the credit cards now.
Ryan Severino: So in terms of its impact, I would say clearly it's not uniform. If you are, just for argument’s sake, say median income and below, then obviously it's having a more detrimental impact on your ability to really function as a normal economic unit. That's a very economist speak I know, but it certainly has the ability to cut into a lot of discretionary spending, really crimp people's ability to leave I think any semblance of what they would consider a normal life. If you are a household that's above median income, you are not unscathed by this, but it's a little bit easier for you to grapple with it because spending categories like food and energy are not as large of your overall budget relative to a household that is below the mean. So clearly it's disproportionate. And that dovetails with your second question. How is consumption being financed? Some of it is certainly financed by the strength in the labor market, by the fact that we have a labor shortage and wage growth is growing strongly, but also because consumer balance sheets are in a very strong position right now, especially those affluent balance sheets.
This is a very different position than we found ourselves in during the financial crisis in 2008, 2009. So some households the ones that don't have as much saved up. Obviously they have to finance consumption out of current earnings, but a lot of those more affluent households, median wealth and above, they are able to dip into those very strong balance sheets. And even with the disruption in the markets, the pull back in the markets that we've seen, they're still sitting on a lot of wealth that they can utilize to go out and continue to spend and maintain a certain quality of life that they would like to sustain.
Travis Epp: As a follow up, Ryan, we talked a little bit about increasing food prices. I know when I go to the grocery store, prices have changed over the last year or two. In regards to the war in Ukraine, given like the production Ukraine being sort of the cereals, the energy products, I have a concern that when the harvest comes through the next year that maybe there's a global impact on sort of the pricing that we haven't yet seen yet as there may be a supply shortage to some of the cereals. What are your thoughts on that and how do you factor that into maybe inflation coming in?
Ryan Severino: Yeah. I think that's certainly true. I think for us in the US, there's some good news and bad news about that. The bad news is food is a global commodity. And if you think about those two components that are disrupted right now, food and energy, energy is much as it's important to our lives in the developed world, in the developing world there are a lot of people who consume very minimal levels of energy, but everybody eats. And that is where I think some concern of mine really comes about. That when we get to the point where the harvest is disappointing, not just in that part of the world, but potentially even in other parts of the world because that part of the world also produces a lot of the fertilizer that gets utilized in other places that it could start to foment social unrest. And that in and of itself is bad enough, but that could certainly spill over into economic consequences in other parts of the world that could create this feedback loop that could actually exacerbate inflation.
For us in the US we're a little bit insulated from this because we are such a dominant food producer in the world. We are a net exporter of food and food related products to the rest of the world. So we do have a bit of a safety net that a lot of other places in the world do not have. But if that persists and we actually see it manifesting in food shortages, we will not come through that unscathed either. That will show up in somewhat higher prices at a minimum, if not something more egregious than that.
Travis Epp: You also mentioned earlier that a lot of companies, as a result of the pandemic, they look at the supply chain and there's more consideration given to onshoring versus what we've been doing when we've outsourced the factory floor overseas. A couple questions there. Are you really seeing more onshoring? And then also because of what we've had in the past with the supply chain, I think part of the inflation was driven by companies really doing panic buying versus a real need at the time. And is that changing now and any thoughts on that as well.
Ryan Severino: So as far as your first point, I'd say it's more the chatter stages at this point, but I think even prior to the pandemic, we were already seeing organizations rethinking their manufacturing and logistics distribution around the world. They didn't want to be concentrated in China, dependent on China given ... And again, no political statement, but just given the government there, I think there was increasing concern about that. Some of that has been moved to the extent that it could into Southeast Asia. But I think given the pandemic, we have certainly seen an interest in companies thinking about bringing that if not explicitly back to the US than somewhere closer to the US. And that has knock on consequences for industrial space, for warehouse space, logistic space, distribution space because the pattern of goods migration is not the same if you are manufacturing is shipping from Asia than if you are from somewhere else in the world. So even just the little bit that we've seen and the conversation that's going on, given how tight the industrial market is starting at least at the margin to show up in some of the data. As far as... I'm sorry, Travis. What was the second part of your question?
Travis Epp: A lot of companies when the pandemic had-
Ryan Severino: Oh, they were running ahead of buying. I would say we haven't seen that as much. I think very quietly and surprisingly, another part of why I think the supply chain looks better in the future is that we've already seen a pretty good rebuild of inventory. And I think that's one of the reasons why you'll also see not just the supply side looking more robust, but probably even an easing and demand in the future. There's very quietly been this I think attractive rebuild of inventory on the part of retailers and organizations. I wouldn't expect to see as much of that going forward, especially if inflation really does start to moderate. I think that would hopefully take more of the wind out of the sales of that dynamic, especially coupled with I think the robust inventory situation that a lot of companies are now sitting on.
Travis Epp: Okay. Switching gears a little bit, Ryan. ESG and corporate sustainability. How is that for companies that have really taken that initiative on seriously and have driven hard, how is that sort of affecting how they're seen by their maybe owners, lenders, and seen by the general marketplace? Is it a positive input for those people?
Ryan Severino: I would say unambiguously it is a positive. And we see that manifest itself in different ways. We see properties that have better consideration for environmental and social impact having higher rents, trading at higher prices. And certainly when you think about those organizations competing in a labor shortage the way that we have today, and this is a point that I make frequently, companies are now not just competing in terms of what they can afford to pay, benefits, packages, things like that, but especially in a world where there's a labor shortage and we're trying to get people back into physical workspaces like offices, the quality of the space is now not just something that the average person doesn't give much thought to. It's considered to be a differentiator. Do you have amenities in the building? Do you have amenities in the neighborhood? And now there is a very robust consideration for social and environmental impact.
Therefore, I think organizations are using this not just to check a box and tell their clients, "Hey, look. We care. We have all of these environmental and social causes that we're supporting." But I think it's also a signaling mechanism in a very tight labor market to say, "Not only are we telling you in terms of how we run our company that we care about these things, but we actually care about them from your point of view and we've gone out and we've secured the most friendly, for lack of a better word, asset for you to work in, for you to tell your peers about, to potentially attract somebody to come over and work with us, that you can go home at the end of the day and think not only is my company telling our clients, our customers that we're doing all of this, they're actually taking action for the employee base as well. So I would say absolutely. We are seeing it show up very clearly in real world data. And I would say we're probably at the beginning of this trend, not at the end of this trend.
Sarah Brand: Ryan, thanks so much. I have one thing. I just want to go off of that. You keep talking about the labor shortage as well. So some questions have come in with their labor shortage. You said 11 and a half million jobs are available. What is creating this labor shortage? And what do we think the impact is? And how can we get that rectified?
Ryan Severino: So the short answer is we are in a very negative demographic situation right now. So just to give you the crib notes answer, the birth rate in the United States has declined considerably over the last 50 years to the point where we're not replacing ourselves anymore, because ... I'll be euphemistic and say people are just not getting jiggy with it in the bedroom the way that they used to. So the birth rate has now fallen below what's known as the replacement rate, which means as people, we're just not replacing ourselves with the subsequent generation. At the same time, and I say this again very apolitically, immigration has declined considerably partially as a function of policies by certain administrations and partially as a function of the pandemic. And as a consequence of those two things, we now find ourselves in a very pronounced labor shortage.
The birth rate situation is a little more intractable. Obviously it can't change that overnight. And even incentivizing people to have more children, the cost-benefit analysis says maybe that's not the greatest thing. We could certainly flip a switch and open immigration, but that's a political football these days. So I don't see that happening, but I think even with that, there's going to be a shortage, which means we're going to have to rely on technology to make us more productive because in the absence of finding people, we, those of us who are going to be working in the economy, have to produce more. We're going to have to produce more cars, more smartphones, more really riveting economics presentations. We're just going to have to find a way to do more ourselves because we're not going to be able to rely on just the idea of going out and hiring people. I see, but I hate to be buzzworthy, but this synergistic relationship between technology and labor, I don't see artificial intelligence, machine learning, robotics automation as a job destroyer. I see it as a compliment to labor. And I think that will help us navigate the labor shortage because it's going to persist for a prolonged period, five, 10, 15 years at least, something like that.
Travis Epp: Ryan, final question. A couple parts to it. So earlier this week, the Federal Reserve Chairman Powell indicated that rate increases increase the rate risk of a recession. Any thoughts on sort of what we should expect through the rest of the year for potential rate increases and the likelihood of recession? I know there's a lot of questions that relate to a crystal ball and there's not known answers, but any thoughts on that?
Ryan Severino: I would say the Fed is clearly bent on at least getting back to neutral, which in my estimation is about two and a half percent on the Fed funds rate. So they're still sitting call it 75-ish basis points below that. I think they're going to aggressively move back there. I think again moving past that increases the probability of a recession. So I think they'll proceed cautiously. I think they'll pay attention to the inflation data coming in. I think they'll look at that excess labor situation and see how that evolves over the balance of the year. I think they're going to try to get a bit above that and see how much restraint it actually causes in terms of economic growth. I'm not wedded to their most recent forecast because the Fed actually has a really bad track record of following through on their own forecast for a metric that they themselves control. But that said, I think they're going to pay attention to the data and see how this plays out.
I think the probability of recession has certainly gone up. And if the Fed embarks on an aggressive course like that, they will push the probability up. But I think in the absence of the Fed really getting aggressive, it's hard to envision with this much momentum, a recession materializing, again, unless inflation really becomes the self-fulfilling prophecy. So I'd say objectively the risk is going up, but I still think the talking heads out there that like to make a lot of noise are making it sound like more of a certainty than I feel like it is at this juncture.
Travis Epp: Ryan, as we hit 1:00, on behalf of EisnerAmper, Sarah, and myself, we want to thank you very much for giving your comments and your insights today. We didn't get to all the questions and we'll try and respond to those people offline. But we really thank you so much.
Ryan Severino: Thanks for having me.
Sarah Brand: Thank you, Ryan.
Ryan Severino: Anytime.
Sarah Brand: Take care.
Transcribed by Rev.com
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