That’s right, we’re talking about the US Economy. Doing its thing. Continuing to show resilience in the face of a persistently high interest rate environment. It’s even got the Fed turning their heads – so much so that they are likely to increase their original predictions for growth in 2023. Now we’re looking at forecasted growth in the GDP of 2.3% for ’23 and 1.5% for ’24.
It’s not all sunshine and roses though, so let’s review some of the bad news. The Federal Reserve is still trying to wrangle inflation – in fact, core inflation increased in August compared to the previous two months with energy prices surging. Given Chairman Powell’s tough stance last week, more rate hikes are probably in store and the rates will remain high for the foreseeable future. The market doesn’t seem to be pricing accordingly, and we believe it will take a recession to get inflation down to the Fed’s 2% target.
We also saw a softening of the labor market in the August job report (and expect it will continue) with unemployment rising to 3.8%. However, we also noticed another significant increase in payrolls, which elevates the demand for goods and services. Elevated demand means increased business revenue, which leads to further expansion to meet the demand.
Finally, Goldman Sachs recently reported that hedge funds have been shorting the market at a rate not seen since March 2020. What followed then was a vicious rally and we expect the same this time around, taking us through the end of the year.
What else can we expect from the US economy in Q4? Let’s check out the risks and the potential rewards…
The risks include inflation, which we already discussed. But additional related consequences could be a slowing of the economy, higher unemployment, a collapse of fragile banks and highly leveraged companies, and a recession. Not… great?
We also have to factor in some domestic and global volatility. Here on US soil, the most immediate risk is the political theater around a government shutdown. The Fed tends to be reactive, making decisions by looking in the rearview mirror and then adjusting forecasts. This may cause them to over-tighten. By the time they realize, the damage to the economy will have already been done.
Globally, the biggest threats are the Russia-Ukraine conflict and the resulting disruptions to food and energy supplies. Asian territorial disputes and China’s zero COVID policies could also be wild cards.
Still, we look for bright lights and opportunities in the fourth quarter.
According to the Investment Company Institute, money market funds were at an all-time high this month. Historically, the stock market has outperformed money market funds at the end of previous tightening cycles. While it could be different this time, with their higher-for-longer rhetoric, money market funds may continue attracting investors until we have more clarity on the timing of the Fed’s pivot.
The final quarter of the year tends to be bullish for stocks. There is an opportunity to buy undervalued stocks that operate in recession-proof industries. The first half of the year saw the indexes make significant gains on the back of the 7 largest stocks. The beaten-down stocks could offer the best value as we move into Q4. Several undervalued companies with low leverage are thriving in the current environment and we continue to invest in smaller companies that present value with robust long-term potential.
The sluggish economic environment will also favor tech stocks, as AI has the potential to change the working world as we know it. Generative AI is spurring productivity and increasing business value. CEOs recognize the potential and are investing in AI to drive productivity and increase value for all stakeholders.
Some commodities, like steel and energy, also continue to look attractive.
We continue to be cautiously optimistic in the short-term but there are dark clouds looming ahead on the horizon.
