More Optimism
January 23, 2023
In January’s ViewPoints, I offered an outlook for a mild recession and struggling equity markets the first half of the year. I pointed out that the outlook was likely to be proven wrong partly because at least one unforecastable event is likely. I did not note that the forecasts could be wrong simply because it’s wrong. The economy and investments should be watched closely and always reevaluated to ensure they still make sense. Where could we be wrong with our outlook? Especially given some recent economic reports released since the ViewPoints article was written.
The first few days of January we received the Institute for Supply Management (ISM) Manufacturing and Services Report on Business. These reports suggest that the manufacturing and services sectors of the economy are contracting. More worrisome though, is they indicate employment in the services sector is contracting following a strong 2022. Collectively, these reports show an economy that is at least slowing down.
On the other hand, nonfarm payrolls showed robust jobs growth in December, with an increase of 223,000, and the unemployment rate edged down to 3.5%. Labor markets suggest a positive outlook for the economy, one of moderate growth and therefore, no recession.
The two ISM reports also indicate that inflation is falling. For example, prices paid by wholesalers are still rising, the year-over-year increases are coming down at an accelerating pace. Additionally, fewer firms are reporting rising prices and an increased number reported falling prices. The consumer price index (CPI) declined by 0.1% as gas prices fell in December. Food price inflation, which was increasing at double digit rates, has moderated over the last several months, rising at an annual rate of 5.6% the last three months. The recent high inflation rate is being driven by housing, which seems to be accelerating. This is more an aberration and shows a weakness of the CPI. Some of the housing data in the CPI is up to 18-months old, and 18-months ago, house prices were rising fast across the country. Today they are declining in most, if not all markets. In fact, over the past six-months the national average of home prices has declined a little more than 3%. Thus, one could argue that inflation is currently artificially elevated because of this stale data. As more recent housing data is incorporated in the CPI, we should see both measures of inflation come down quickly. This would give the Fed room to slow down their rate increases and this would be very welcomed news for consumers and businesses, and therefore for the economy and capital markets.
What does this mean for the economic and market outlook? Our view has been that inflation will come down quickly and this data overall supports this outlook. The data also supports the idea of the Fed ending their regime of rate increases sooner rather than later, and that the Fed can engineer a soft-landing, avoiding a recession. Further supporting the no recession outlook are the stale housing market data that is keeping inflation artificially high and the fact that so many market prognosticators are calling for a recession before July, and since so many are looking for one, it probably won’t happen. The best thing to say is, Stay Tuned.