It’s the height of summer and it feels like the year is flying by, with just 5 more months left in 2023. Where does the time go? And, more importantly (for our purposes), which way is the economy going?
With the news cycles reporting the Dow’s longest winning streak since the 1980s, folks are wondering if the euphoria will carry us through to Christmas. Let’s take a deeper dive into the economic indicators to sort out what’s really going on, and what’s likely to be in store.
It seems that in these bright, sunny days, the markets have put the banking crisis and the high-interest rate environment behind it. The stock market is grinding out wins and climbing higher in an impressive rally amid lower summer volume,
That’s good news, but we took a closer look under the hood and found something interesting: while the overall performance of the stock market year-to-date looks impressive, the truth is that it was the 7 largest tech stocks that ultimately contributed to this increase. Remove these 7 stocks from the S&P and the results are a year-to-date increase that’s only in the low single digits.
There are some other risks looming on the downside, as a few major indicators seem to be retracting. Manufacturing activity, for one, shows signs of slowing down. Recent job growth has been sluggish and data reports on household spending are also underwhelming.
Inflation played an outsized role in economic forecasting, commentary, and public perception. It seems, at last, that the peak is finally behind us! Good news, but again, there’s some nuance to address. The decline was largely driven by a collapse in energy prices. Core inflation, which excludes food and energy, has been stubbornly high and declining at a slower rate.
Meanwhile, the Federal Reserve continues to tighten. We already witnessed the initial shock waves of the high-interest rates rippling through regional banks; now these high-interest rates will start slowly working their way through consumers. Expect to start seeing more credit card and auto loan delinquencies.
Tech companies are trending towards employee layoffs. We are watching closely to see if expansion plans and capex spending in other sectors have been put on hold, as this could quickly lead to a downward spiral that will rapidly gain momentum.
All things considered – and believe me, we consider all the indicators in play – our outlook for the rest of the year is cautiously optimistic. Where we have concerns is whether or not the market is properly pricing in the following risks:
Recession: A few of the reliable leading indicators, like the inverted yield curve, manufacturing activity, and the Baltic Dry Index, are still pointing to a recession if historical trends remain consistent.
Rising Interest Rates: Core inflation continues its slow descent, yet the Fed is still aggressively raising interest rates in an attempt to get that stubborn core inflation down to its target of 2%.
Overpriced Equities: To justify their current valuations, companies will have to keep increasing their earnings per share (EPS) in order to justify their current valuations. In today’s economic environment, that is looking difficult for most sectors.
On the positive side of the scoreboard, consumer sentiment rose to a nearly two-year high earlier this month.
Put all these factors together, and our prediction is that the rally we just experienced is unlikely to extend into the fall. The risk is to the downside. In order for the stock market upswing to last, there needs to be meaningful growth in gross domestic product (GDP), and that’s not a sure bet right now.
All in all, it’s not the doom-and-gloom that once seemed likely, but it’s not Christmas in July either. Proceed accordingly – and with caution!
