Focused Investing: Economy & Markets Update

Economic forecasts are known to be wrong most of the time. Even the best forecasters suffer through periods of incorrect predictions. There are many reasons why this is the case. Sometimes the forecaster does not include needed data, a surprise event, either positive or negative, could move the economy away from the expected path and overconfidence of the forecaster. Other times, it can simply come down to conflicting data. We believe the latter reason to be the case in the current environment after helter-skelter signals from last week's releases.

Economy

Last week’s major economic releases offered a picture of a slowing economy, or an improving economy. The housing market appears to be slowing as homebuilders were more pessimistic this September than they were a month ago and housing starts fell by 170,000 units. Existing home sales declined slightly to 4.04 million from 4.07 million units. Additionally, the S&P Flash Services index declined to 50.2 suggesting the services sector of the economy may finally be cooling. The last bit of negativity reported was the Philadelphia Fed manufacturing survey, which posted a large drop from expansion to contraction this September. It is important to note, this survey is specific to the Philadelphia Federal Reserve district, it is not a national measure. Nonetheless this survey gives a contrary signal to the S&P flash manufacturing which improved to 48.9 from 47.9 the month before. The report shows that the manufacturing sector is still contracting; since it moved closer to the break-even point of 50, the results suggest the manufacturing sector isn’t doing as bad as it was in August and early this September. Also, labor markets still look strong as initial jobless claims declined by 20,000 resulting in 201,000 claims.

The biggest new last week occurred in the Fed meeting. Chairman Powell spooked the markets (Happy early Halloween), by stating that rates will be higher for longer with maybe one additional increase to fight what may be persistently higher inflation. Following these comments, interest rates jumped 4.31% on the 10-year Treasury, to just under 4.5% at the end of the week.

In total, these reports do not show an economy struggling under the weight of inflation and higher interest rates, instead, these metrics do show a slowing economy. The questions, of course, are: which way will the economy go? Will growth accelerate, or will we fall into recession?

Capital Markets

Taking cues from the bond markets, equity markets dropped following the Fed press conference, finishing 2.9% lower on the week. A positive change for consumers was the drop in oil prices, as they were down last week with WTI falling 1.3%, perhaps temporarily slowing what the rapid rise in oil prices in late summer. We expect the rise in oil prices will shift some consumer spending away from discretionary items to gas purchases. As with past spikes in oil prices, consumer behavior is unlikely to change significantly. We believe that consumers are beginning to moderate spending; our expectation is this will continue and may even accelerate to the end of the year. This may be because consumers are tapped out, the stimulus payments from the pandemic have largely been spent, and consumer credit card balances now exceed $1.01 trillion, and delinquencies are rising rapidly.

These reports still lead us to conclude that we should be cautious on stocks and more optimistic on bonds. We believe the Fed is basically done raising rates, so yields are likely to reverse leading to higher prices and better performance for bond holders. Even though we are cautious about stocks overall, there are sectors and individual companies we are excited about both near-term and long-term.

Overall, we believe the economy will slow more than it has to date, but we may be able to avoid a recession this year because of the labor market strength and presumed reluctance by corporations to cut headcount. The Fed rate increases have not yet fully worked their way through the economy, thus opening the possibility that the economy could slow more than even the best forecasters are expecting.