It wasn’t looking good. Conflict in the Middle East threatens to spike energy prices. A drawn-out labor strike pitting the United Auto Workers against unionized automakers threatens to derail an industry on the brink of recovering from supply chain disruptions. A strong dollar and long-term yields hovering around 5%. In spite of it all, the US economy continues to surprise naysayers with its resilience.
Third quarter reports are in and they are surprisingly… good! The US economy continues to march ahead, seemingly impervious to dark clouds that are looming. (The recent downturn in risk assets, including equities, is a very normal correction in what we believe is a bull market.)
While the economy likes to keep us guessing, we can glean some clues as to where it’s headed next if we take a closer look at some data points.
GDP: Initial forecasts predicted that the real US GDP would grow by an annual rate of 2.1% this year. Imagine everyone’s shock when it came in at 4.9% for Q3, far surpassing anyone’s expectations. Consumer spending, increased inventories, exports, residential investment, and government spending all played a part in this startling comeback.
Consumer Spending: Personal consumption expenditure increased 4% for Q3 (after rising just 0.8% in Q2.) We saw quite a shift – a .5% increase in spending in June versus a 4.8% increase in August. This increase in spending comes on the back of increased prices. Consumer prices increased 3.7% year-over-year. In September, food prices were 3.7% higher than a year ago, while energy prices were 0.5 percent lower. Prices for all items less food and energy rose 4.1 percent over this 12-month period. Consumer spending is a key indicator in the health of the economy.
Corporate Earnings: Third-quarter data from Factset (with 17% of S&P 500 companies reporting actual results) shows that 73% of S&P 500 companies reported a positive EPS surprise and 66% reported a positive revenue surprise. It might not be enough, though – early estimates for this quarter predict a lower Year-Over-Year Net Profit Margin for the 7th straight quarter.
Jobs: Though jobless claim applications rose by 10,000 to 210,000 for the week ending October 21, the previous week’s applications were the fewest in eight months. They remain historically low, implying that the labor market remains strong. (Employers added 336,000 jobs in September!)
A low unemployment rate bodes well for the economy: more people at work means more productivity, more paychecks, and, ultimately, more consumer spending that fuels economic growth.
Even with all these positive surprises, there are risks on the horizon that we must heed. For now, though, we believe that risk assets will offer the best returns through the remainder of 2023 and through early 2024. Now is the time to ‘hold ‘em’. The time to ‘fold ‘em’ and run is coming (keep reading to see why) but not just yet.
We painted a pretty sunny picture, but we need to talk about those dark clouds that still hang over us. For starters, inflation continues to escalate and mounting conflict in the Middle East could send oil prices sky-rocketing.
US Treasury Yield Curve: It’s inverted at the moment, meaning short-term interest rates are higher than long-term interest rates. Historically, this unusual occurrence has been a reliable indicator of an upcoming economic recession.
Housing Market: A mixed picture here. Despite negative sentiments, new home sales in September rose by 12.3% over the previous month after a big decline of 8.2% in August. The supply of homes is lower than demand and there is an increasing clamor for adjustable-rate mortgages.
No Soft Landing: The mainstream media seems to think that the Federal Reserve will engineer a soft landing that averts a recession. In reality, the Fed is impotent, merely reacting to market forces. While unlikely to raise interest rates at the next Federal Open Market Committee, they have been openly resolute about maintaining these higher rates.
We anticipate that they will keep rates too high for too long. By the time the lagging data reflects their intended results, the damage to the economy will be done. Central bankers hope to accurately account for these delays and the associated consequences, but high borrowing rates will challenge over-leveraged corporations and consumers will feel the pinch of keeping up with payments on maxed-out credit card balances.
We anticipate that the US economy will move into a deep recession sometime in 2024.
But, hey, who doesn’t love an October surprise? The economy is resilient at the moment, and we can be strategic about making the most of it while the good times roll!
