At the midpoint of 2023, there are reasons for optimism, despite the prevailing atmosphere of uncertainty and change in the global economy. Ongoing transitions in the financial markets, concerns surrounding inflation, the upward trajectory of interest rates, and the looming possibility of a recession profoundly influence the current landscape.
The risks have also grown. Not just market and economic but policy risks. Where does the United States stand concerning China? Will the war in Ukraine escalate? How will regulators respond to the crisis of confidence in the banking sector? These issues demand careful consideration as we evaluate potential investments. Embracing short-term discomfort may lead to long-term benefits. Industries sensitive to interest rates are experiencing the effects, such as home prices falling in previously thriving markets.
While inflation remains above the U.S. Federal Reserve's two percent target, it is essential to note that monetary policies operate with long lags. The full impact of rate hikes gradually permeates the economy. The chart below illustrates historical inflation trends, highlighting the rise since 2021, which affects various economic sectors.
The above chart indicates inflation has shifted from goods to services. This makes sense in light of the purchasing frenzy during the height of the COVID-19 pandemic in 2020-2021. People purchased cars, computers, and office furniture. Homes were remodeled or new ones bought. At the same time, the service sector (i.e., restaurants, airlines, hotels, hospitality industry) was lackluster. People did not go out as much. That has changed. Services have become the most significant inflation contributor.
The disruption to spending patterns is evident in the chart below. The purple line represents purchases of durable goods, and the orange line represents the service sectors. It is normal to see changes in spending patterns, particularly during recessions. However, supply chain constraints were created with the economy shutting down and the injection of government stimulus funds. Businesses stockpiled materials. Factories closed. Orders were delayed. With shipping constraints, deliveries were backlogged for months. At the height of supply chain issues, more than 100 container ships waited to unload at California ports. No wonder prices increased.
The initial drop in spending as the economy shut down is evident above. The subsequent rise in spending can be noted as stimulus money reached bank accounts. That money entered the economy through personal expenditures and the stock market. Notice how the market responded to the inflow of money, as shown below.
Consider the trend line in the chart above from March 2009 to February 2020, just before the COVID-19 pandemic. Then the trajectory shifted almost vertically, resulting from pandemic-influenced stock purchases. Much of this was housing and technology purchases — for remote working and learning. Additionally, record automobile and recreational vehicle sales created inventory reductions and shortages. Then in 2022, there were significant corrections in the markets, including the bond sector. The chart below shows that bonds had one of the worst years in history.
Are we headed for a recession?
There is a saying on Wall Street: "The Fed takes the stairs up and the elevator down." This time it feels like the Fed has taken the elevator up, too. Interest rates have risen at the fastest clip since the 1970s with efforts to tamp down inflation.
Before 2022, people in the United States borrowed money at nearly zero-percent interest. There was little concern about the consequences of free money, the threat of inflation, or that central banks might raise interest rates. Times have changed. We expect rates to remain higher and believe they need to stay elevated. Looking back at the federal funds rate expectations in December 2019 versus those of June 2023, the charts below display drastic shifts in how the Fed manages interest rates.
Also note that the Fed's policies seem to be working, as inflation has fallen from a peak of 8.5 percent to a current 4.1 percent. It is likely to fall even lower after inflation data for June 2023 becomes available.
In the chart below, green designates that recession-determining variables grew month-over-month, and red indicates that they fell. The shading or boldness of the colors illustrates how substantial the gains or losses were historically. While it doesn't look like the economy is currently in a recession, this is something to monitor closely.
Since 1950, the average recession has been ten months. Often by the time it is learned that the economy is in a recession, it is well on its way through it. The average expansion, on the other hand, is 69 months. This potential recession may be the most widely anticipated in history. The question is: What comes next?
Catalysts for a subsequent recovery
With a multi-decade low of 3.5 percent, unemployment has helped avoid a recession thus far. It is an indicator of consumer demand and is positive for earnings but potentially negative for inflation and interest rates. Keep in mind that low-unemployment rates help recessions to be milder when one occurs.
Companies and industries have been expecting economic weaknesses, taking preemptive actions, cleaning up inventories and balance sheets, and focusing on efficiency and productivity. Last year many firms trimmed their workforces — primarily sectors in real estate, tech, and finance — to be more efficient in anticipation of slowdowns. Companies have had time to prepare for a potential recession. That's good news. As the economy slows, unemployment may rise. We anticipate a five percent unemployment rate closer to 2024.
The U.S. consumer sector is in good shape. Consumer debt is low relative to levels during the global financial crisis in 2008. A healthy jobs market, wage growth, and household wealth are key catalysts for a more robust recovery.
Strong consumer spending, which affects 67 percent of the economy, boosts a range of industries, including travel and leisure. New home sales continued to recover in May, rising for a third consecutive month to hit the fastest pace in over a year. The main issue with the U.S. housing market is declining affordability, thus the increase in multi-family housing. It is the hottest since 1986. With interest rates in a normal range, there is sticker shock on mortgage rates. However, homebuyers will eventually adjust, possibly by looking at lower-priced homes.
Tech stocks are back, leading a burgeoning recovery. Amazon, Apple, Microsoft, Meta, and Nvidia are the top five contributors to the rise of the S&P 500 Index this year, as of May 31.
The rise of artificial intelligence (AI) systems, such as ChatGPT, is one of the factors driving enthusiasm for the tech sector. There will likely be productivity gains from automation and the increased adoption of artificial intelligence. This may provide economic tailwinds by helping to manage rising labor costs.
There is significant progress concerning tamping down inflation. Supply chain issues are being resolved, commodity prices have stabilized, and goods purchases have decreased. Consumers have low-debt levels relative to those coming out of the global financial crisis.
Final Thoughts:
Historically, the stock market anticipates, recovers, and rebounds ahead of economic turns. It behaved well during the second quarter of 2023. The S&P 500 exited the longest bear market since 1948.
We have likely not seen the last Federal Reserve rate hike. The markets anticipate an end soon — one more hike of .25 percent and then a pause. At the June meeting, Chairman Powell was clear in stating that “inflation pressures continue to run high, and the process of getting inflation back down to 2.00% has a long way to go,” suggesting that future rate hikes remain under consideration. We believe there will be a robust economic recovery.
Staying informed, being adaptable, and focusing on long-term goals helps us navigate the uncertainties and seize opportunities in this evolving economic landscape. Thank you for your continued support and trust in Seamount Financial Group.
If you have any questions or wish to discuss your current financial situation, don't hesitate to contact our office at 719-471-1171 or seamountfinancial.com. We hope you enjoy your summer.
Sources: Bureau of Economic Analysis; Robert F. Carey,Chief Market Strategist, First Trust Capital Group Mid-Year 2023 Outlook; Bureau of Labor Statistics; Wall Street Journal; JP Morgan Guide to the Markets
S&P Index is an unmanaged index of 500 common stocks generally considered representative of the U.S. stock market. The performance of an index is not illustrative of any particular investment, and the performance figures quoted are historical. It is not possible to invest directly in an index. This material may contain an assessment of the market environment at a specific point in time. It may also contain forward-looking statements regarding future events or future financial conditions. Actual events or conditions may differ materially from those expressed in this material. These statements are based on our current beliefs or expectations and are subject to uncertainties and changes in circumstances, many of which are beyond our control. The readers should not rely on this information as research or investment advice, nor should it be construed as a recommendation to purchase or sell a security. Past performance is no guarantee of future results. Investments will fluctuate and, when redeemed, may be worth more or less than when originally invested.
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