Focused Investing: Economy & Markets Update
Last week’s economic reports were highlighted by Friday’s personal consumption expenditures report. This report showed consumer spending remained strong, but inflation, excluding food and energy, was below expectations. Also released last week was the final estimate for second quarter gross domestic product growth and initial jobless claims, both below expectations. On balance, last week’s reports showed a cooling economy, but strength in the labor markets is giving hope that the Fed will be able to engineer a soft-landing of the economy.
The Economy
The personal consumption expenditures price index increased 0.4% month-over-month in August, right in line with expectations. However, the core inflation measure, which excludes food and energy prices, increased 0.145% over July, or 1.7% annualized. This increase was below expectations and shows that inflation pressure from the services sector may finally be easing. Since December 2022 services, inflation is up 2.9% and the rate of growth has been falling. Services inflation has been stubborn, but this stubbornness may be at an end. Inflation on goods is up 0.7%, annualized, since December. The negative component of inflation is energy prices; oil has moved above $90 a barrel from below $70 in July. It is possible that the rise in oil and gas reverse the positive downward trend of inflation and will begin to hit overall consumer spending.
Labor market strength continues as first-time unemployment claims for the week ending September 23rd came in below expectations at 202,000. This level would be consistent with jobs growth of about 170,000 for September, which comes out Friday. The strength in the labor markets and the lower inflation metrics keeps alive the expectation of a soft-landing of the economy following the Fed rate hikes. We do caution, there are many components of an economy, and many have delayed effects on growth. For example, we have mentioned many times the strength in the labor markets and the outlook that this strength can help avoid a recession. But changes in the Fed funds rate have a delayed effect on all areas of the economy, and with respect to unemployment, that delayed effect may be as long as 24 months, as the chart below shows:
This chart shows that labor markets typically react between 18 and 24 months following the first Fed rate increase, and September marks the 18-month point. Thus, we will need to continue to see low first-time unemployment claims to boost our confidence that the Fed can engineer a soft-landing.
Capital Markets
October marks the start of a new quarter, which means third-quarter earnings reports will be coming out in the second week of the month. The first companies to report are the banks, so we will get another look at how the higher rates are impacting lending to business and consumers. Year-over-year earnings growth has been negative, and we expect third-quarter earnings will continue that trend as more companies are issuing a negative outlook for the third quarter. Real estate is the only sector telling investors that third quarter earnings will be better than expected; while tech, healthcare, and industrials have a double-digit number of companies issuing a negative outlook. We have been expecting more downside in earnings and have been positioning client portfolios accordingly by reducing equities and adding to bonds. We are excited about the third quarter earnings season to find out what corporations think about the next 12-month’s activity in their business and industry.
Overall, we believe the economic reports are positive, but we are now entering the period when the Fed’s rate hikes really start to hit the economy. Reports coming this week include activity in both the manufacturing and services sectors and jobs market with both the ADP Employment and the non-farm payroll reports out later in the week. If you have further questions regarding these updates, our team is here to share our knowledge. Explore our website for past Focused Investing blogs or contact our office at 503-292-1041.