Reading his own obituary in 1897, Mark Twain is reputed to have commented, “The reports of my death are greatly exaggerated.”

Ditto for San Francisco.   No, by my observation the city was not vibrant and energetic as it was in years past. But nor was it a ghost town.   I drove much of the city … the “good” parts and “bad” … and I’m here to tell you much of the city was quite clean and livable.   I expected to see rampant and widespread property damage, graffiti, homeless encampments, drugs, etc.   And while there are harsh geographic areas one should probably avoid, I found most of the city to be quite nice.

On the other hand, the city did feel a bit deserted to me.   Foot traffic was generally light and there are many retail vacancies looking for new tenants.  The city is definitely still feeling the residual effects of Covid and other well-known problems.   The areas I drove generally looked nice, but without many people. 

Unfortunately two (2) of the four (4) steakhouses we track at the SHI — Mastros and Alexanders — are not in what I would call “nice” areas.   While in SF, I dined at Epic Steakhouse down in the financial district, and drove by Harris; but, frankly, I’d be frightened to park my car and walk my family to either Mastros or Alexanders after dark.    Epic, however, was delightful.   Great location.  The steaks and “sides” were all quite nice and the wine was perfect.   Of course, that’s because I brought my own:   I came to San Francisco after spending a few days in Napa.  🙂

 

Welcome to this week’s Steak House Index update.

 

If you are new to my blog, or you need a refresher on the SHI10, or its objective and methodology, I suggest you open and read the original BLOG: https://www.steakhouseindex.com/move-over-big-mac-index-here-comes-the-steak-house-index/

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Why You Should Care:   The US economy and US dollar are the bedrock of the world’s economy.   But is the US economy expanding or contracting? Expanding ….  By the end 2023, in ‘current-dollar‘ terms, US annual economic output rose to an annualized rate of $27.94 trillion.   After enduring the fastest FED rate hike in over 40 years, America’s current-dollar GDP still increased at an annualized rate of 4.8% during the fourth quarter of 2023.  Even the ‘real’ GDP growth rate was strong … clocking in at the annual rate of 3.3% during Q4.

According to the IMF, the world’s annual GDP  expanded  to over $105 trillion in 2022.   Further, IMF expects global GDP to reach almost $135 trillion by 2028 — an increase of more than 28% in just 5 years.

America’s GDP remains around 25% of all global GDP.  Collectively, the US, the European Common Market, and China generate about 70% of the global economic output.  These are the 3 big, global players.   They bear close scrutiny.

 

The objective of this blog is singular.

 

It attempts to predict the direction of our GDP ahead of official economic releases.  Historically, ‘personal consumption expenditures,’ or PCE, has been the largest component of US GDP growth — typically about 2/3 of all GDP growth.  In fact, the majority of all GDP increases (or declines) usually results from (increases or decreases in) consumer spending.  Consumer spending is clearly a critical financial metric.  In all likelihood, the most important financial metric. The Steak House Index focuses right here … on the “consumer spending” metric.  I intend the SHI10 is to be predictive, anticipating where the economy is going – not where it’s been.

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Taking action:  Keep up with this weekly BLOG update.  Not only will we cover the SHI and SHI10, but we’ll explore “fun” items of economic importance.   Hopefully you find the discussion fun, too.

If the SHI10 index moves appreciably -– either showing massive improvement or significant declines –- indicating growing economic strength or a potential recession, we’ll discuss possible actions at that time.

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The Blog:

 

San Francisco definitely needs a reboot.  

 

It might be in the beginning of one right now, but economically it has a long way to go.   Many companies and people have left the city.   Which adversely impacts property values, retail sales, hotel stays, etc.   And, of course, all of these factors adversely impact city tax revenues from all sources.   The city has economic work to do … but overall, I was pleased with the “look” and “feel” in most areas I visited.  

As you know, San Francisco is home to one of the twelve (12) ‘Federal Reserve District’ banks.   Eight (8) times a year, the FED produces the Beige Book, which is an anecdotal commentary on current economic conditions in the local District.   Data is sourced through reports from Bank and Branch directors, and interviews with key business contacts, economists, market experts, and other sources within the local area. The San Francisco “Beige Book”, thus, is a summary of all this data.  The most recent report was published a few weeks ago.   Here are some excerpts:

 

Federal Reserve Bank of San Francisco

Summary of Economic Activity:  Economic activity in the Twelfth District (San Francisco) was unchanged on balance during the April through mid-May reporting period.  Employment levels were generally flat, and labor was more available.  Wages grew slightly, and contacts reported lower goods prices and higher services prices. Retail sales grew slightly. Activity in services sectors weakened a bit, as did activity in residential real estate markets.  In contrast, commercial real estate activity was unchanged.   Activity in the financial services sector remained largely unchanged.  Communities across the Twelfth District sought services for mental health support as well as housing and food assistance.  Looking ahead, contacts expect a modest decline in economic conditions overall.

 

This is certainly not a horrible report, by any measure, but by no means is it overly positive.  Here are a few more comments from the San Francisco write-up:

 

Labor Markets:   Employment levels were generally flat over the reporting period. Reports of low attrition rates continued, and employers preferred to fill only critical positions.

Community Conditions:  Conditions in the community support and services sector worsened somewhat in recent weeks. Demand for mental health services, housing assistance, food assistance, and other related services remained high.

Retail Trade and Services:  Retail sales grew slightly over the reporting period. Consumers continued to buy lower cost items, and they reduced spending on nonessential goods.

Manufacturing:  Manufacturing activity picked up slightly.

Real Estate and Construction:  Activity in residential real estate slowed further. Single-family home sales fell amid continued low inventory.  Commercial real estate activity was unchanged on balance.

 

Clearly, San Francisco is a city struggling to find its economic footing.  

Fortunately for the US economy as a whole, San Francisco is an outlier.  The majority of the US economy has been performing quite well, as I’ve reported in prior blogs, even if some reports have suggested economic output might be slowing.  After years of ‘real’ growth in the 2-5% range and ‘nominal’ growth between 5- and 10%, data suggests both are slowing.   To quote one of the talking heads on CNBC, “Some cracks are beginning to appear.”   

Over the past year of so, I’m sure you have heard the phrase “long and variable lags” a few times.  The concept originated from the Nobel prize-winning economics Milton Friedman, first in his book titled  “A Program for Monetary Stability”  when he commented that “monetary changes have their effect only after a considerable lag and over a long period” and that this lag is “rather variable.”

According to a write-up about the book by the Federal Reserve Bank of St Louis, “Friedman examined peaks and troughs in the rate of change in the money supply and in general business (what today we might associate with things like employment, consumption and real gross domestic product) over 18 business cycles in the mid-19th to the mid-20th centuries.  Milton found that the lag between monetary policy action and its economic effect ranged between four and 29 months, but also that there was little basis for knowing where in this range it would fall.”

Today, central bankers generally quote 18 months – “ish” for this lag to play out.   This time, due to the exceptionally low level of interest rates for years before the FED began tightening, many individuals, business and large public companies had “locked in” or fixed lower rates when they had the chance.   Many homeowners still have interest rates in the 2s and 3s.   Many businesses floated long-term debt with similar interest rates or coupons. 

But I think it’s time, using a food metaphor, as this is the Steak House Index after all, to claim the chicken has left the roost, the cow has left the barn, etc. 

 

I am officially declaring an economic slowdown is here. 

 

But don’t overreact.   I am not suggesting a recession is around the corner.   I’m only saying the torrid pace of the US economy is slowing.  How much you ask?   Unknown.   Remember, employment levels remain at or near 50 year highs.  People are working.   But consumer price levels are quite high — most economists agree they are about 25% higher than pre-Covid — and this is putting a crimp in both retail sales and consumer confidence.   Consumers are not happy.   Retail sales are still expanding, but at a slower rate.   And consumer confidence has definitely taken a step down. 

But no where is this slowdown more obvious than in new home construction.   New home construction requires billions of borrowed dollars.  Thus, clearly, higher interest rates will ultimately adversely impact the level of building permits — and, in fact, this is the case today. 

Below is a 60 year history of building permits pulled in the US.  

Our housing shortage became much more acute between 2005 and 2009.    As we see below, nationally building permits peaked at almost 2.3 million per year toward the end of 2005, and then plummeted to a 60+ year low of only 513,000 units (annualized rate) by early 2009.    Remember:  This number includes ALL building permits.   Single family, condos, apartments … everything.  

 

 

And while new home creation plummeted thru 2009, the US population continued to grow.    The US economy began to heal in 2010, demand for housing outpaced new supply creation and, as usually happens in such cases, the “price” of housing increased. 

As we see above, the housing unit deficit grew in size from 2010 to 2020, as interest rates continued to move lower and lower.   You remember all the “negative” sovereign debt discussed in this blog, right?

And then Covid hit America in 2020.   Interest rates fell to zero percent.  Everyone, across the globe, was told to stay home.   Unsurprisingly, thru this lens, we now know that those super-low interest rates and increased demand for housing — as only a handful still went to an office every day — inspired a building boom, as we see below.  Much of the construction activity was in the multi-family space as building permit issuance exploded across the country.

Then, in March of 2022, the FED began their rate hike cycle.  And the trend reversed somewhat.

 

 

 

The bottom line:   We don’t need to look much beyond the chart above to find evidence of that higher interest rates are economically caustic.   The vertical red line marks the beginning of the FED rate hikes.   New housing permit applications began their decline, it appears, when the threat of rate hikes began.    And they’ve been plummeting ever since.   Once issued permits fall, construction activity follows shortly thereafter.  

But what are the steak houses telling us?  Biting into the meat of the matter — effectively, reading the tea leaves — at the SHI, I am now convinced the US economy is slowly slowing.   

 

Here is the longer-term trend chart:

 

 

This week’s negative SHI40 reading is telling.   After weeks of smaller and smaller SHI40 numbers, we’ve finally turned negative.  

Ultimately, while the tug-of-war continues between the CPI and the official “housing cost” component within, there is one clear and distinct conclusion:  

 

The FED must reduce interest rates soon.  

 

As the economy continues to slow, the FED will be motivated to soften their stance.   They must.

Further, the FED Ph.D eggheads must have realized by now that higher interest rates only exacerbate the housing shortage.   The data is clear:   The longer rates stay higher, the lower new building permits will fall.   It’s ironic that the FED is attempting to reduce the inflation rate with higher interest rates while, at the same time, higher interest rates reduce new housing production, further exacerbating the housing shortage, thereby increasing the supply/demand imbalance, creating additional rent and home price increases, which, finally, in turn, pushes up the inflation rate. 

What’s the poor FED to do when both choices are sub-optimal?  

Lower rates.  That’s what.   And they will.   The first FED rate cut is on the near-term horizon. 

Yes, I now feel the US economy is definitely slowing.   The SHI40 agrees.   But remember, slowing is not stopping.  I still envision GDP growth near the FED’s expectation of around 2% — and that’s the ‘real’ rate, meaning the current-dollar growth rate is likely to still exceed 4%.   Growth will continue.   Just a bit slower than before.  

<:>   Terry Liebman