Markets and Economy Update – May 2023
Throughout the years, I’ve been somewhat fascinated by the evolution of punditry on television and across many of the other media outlets in America. In my younger years, I remember being enthralled by ESPN’s Chris Berman and Tom Jackson as they recapped the action across the National Football League each Sunday evening on NFL Primetime. They’d show highlights and lowlights of every NFL matchup while teaching the viewer a few interesting lessons about the game and inserting a few corny player nicknames like Eric ‘sleeping with’ Bienemy or Jake ‘daylight come and you wanna’ Delhomme. Apparently, Chris Berman’s influence helped set the groundwork for what would eventually become my awful, cringe-worthy dad jokes.
As the years progressed and new shows emerged, lessons and insights evolved into opinions or ‘takes’, and sports recap shows seemed to turn informative dialogue into shouting matches. That punditry trend, for the most part, seems to have become prevalent regardless of subject matter, from sports to politics to music to investing. Everyone’s an expert.
In my job, I consume a tremendous amount of information about the economy and financial markets every single day, and I absolutely love it. Typically, I like to go directly to the data source to get the information I’m seeking. However, inevitably, I’ll come across an article, video, blog or tweet from an expert or analyst who, with great passion and unshakable confidence, predicts a catastrophic outcome for a product, a company, a business sector, or the economy as a whole. This person is so utterly convinced of their prediction that I might even find myself becoming persuaded for a moment or two. “He/she just seems so damn convinced that they’re right!”, I’d think to myself. After all, I’m not entirely immune to emotion during volatile markets.
However, this is when I remind myself to take a step back, take a few deep breaths, and reflect upon what the data and my arduous years of experience are telling me. After all, public experts and analysts can be wrong. In fact, they are wrong in the majority of cases, and I’ve seen that play-out time after time, market-cycle after market-cycle. These past 18 months have been no different. For over a year, there have been many analysts and experts that have been aggressively pounding the drum and vociferously predicting not only recession in the U.S., but a deep one. Yet, as the chart below (found through Twitter, ironically) illustrates, that recession prediction seems to shift further and further into the future as new data emerges day after day, week after week, month after month. Eventually these predictions will be right, but will it be in 2023 or 2033?
For individual investors, it can be challenging to keep one’s investments fully deployed or even sleep soundly each night in the face of dire predictions coming from all angles. At Destiny Capital our outlook continues to be that a ‘soft landing’ may still be in the cards for the U.S. economy in the quarters ahead. Will we get two quarters of sub-zero GDP growth at some point over the next 12-months? Perhaps. However, will the economy, or investors, truly feel the difference of GDP at -0.40% vs. +0.40%?
Since the Fed embarked on its hawkish mission against inflation, my primary concern was that ‘the Fed tightens until something breaks.’ That has largely played-out as we’ve seen rising interest rates pummel bond portfolios of certain banks which hastened the demise of Silicon Valley, First Republic, and Signature banks. Yet, fortunately for investors, the impact of that crisis on financial markets has been muted. The recession that, to many, was imminent a year ago may not seem so inevitable after all.
In this month’s letter, we’ll discuss why a recession may not be entirely imminent, and we’ll provide some important updates, including a debt ceiling resolution that removes a significant element of uncertainty for investors in the months ahead.
On June 2nd, the Bureau of Labor Statistics (BLS) released their jobs report, indicating that 339,000 nonfarm payrolls had been added in the month of May, as seen in the chart below. This figure was well above the consensus estimate of 195,000.
During lunch on the day of the BLS jobs report, I scrolled through social media looking at analyst reactions to find an ‘influencer/financial advisor’ proclaiming “the Fed’s not going to like this jobs report!!!” I simply had to chuckle.
The Fed has a dual mandate – full employment and stable prices. Thus far, and against most odds, the U.S. economy has managed to navigate historical rate hikes without plunging into an abyss while seeing the unemployment rate leap to 5% or much higher. To think that the Fed would cringe at a positive jobs report is laughable. In fact, I’d imagine there would be a few high fives (and looks of relief) as the Fed reviews charts like the one below, which shows the fed funds rate along with the U.S. unemployment rate. If the Federal Open Market Committee (FOMC) were entirely forthcoming, I’d wager that they would’ve expected the orange (fed funds rate) and blue (unemployment rate) to trend in the same direction at some point over the past six to eight months, yet, it hasn’t.
We also got a bit of a surprise from the Job Openings and Labor Turnover Survey (JOLTS) report, which indicated that job openings had risen from 9.74 million jobs in March to roughly 10.10 million in April. Many economists expected to see a continued decline in job openings, yet job openings still remain anchored well above pre-pandemic levels.
The news isn’t entirely rose-colored for the labor market, however, as wage growth has regressed, the unemployment rate rose slightly from 3.4% to 3.7%, and weekly initial jobless claims have been somewhat elevated in recent months relative to the figures since the beginning of 2022, as seen below.
The bottom line is that a resilient labor market decreases the chances of a recession materializing in the next two to three quarters. Even if we get two consecutive quarters of negative GDP growth, it would be hard to imagine the National Bureau of Economic Research (NBER) making a recession declaration without a subsequent spike in the unemployment rate. And if the Amazon, FedEx, and UPS trucks zooming around my neighborhood are any indication, if Americans have jobs, Americans tend to consume. Furthermore, we continue to see progress on two areas of near-term economic & investor uncertainty, the debt ceiling and inflation, so we’ll briefly touch on those two topics next.
Debt Ceiling Deal at the Deadline
With mere days to spare before the Treasury Department would run out of money to meet the country’s obligations, Democrats and Republicans came to an agreement on the debt ceiling. Purely from the perspective of investors, this debt deal is a good outcome because the potential for a default could’ve been catastrophic and caused tremendous volatility in both stock and bond markets.
Quite often, lawmakers make an interim deal that kicks the can down the road a few months and keeps the debt-limit uncertainty top-of-mind, but that’s not the case this time, either. In this deal, the debt limit is suspended through January 1, 2025, which takes a debt ceiling debate and default risk off the table – for the immediate future, at least. On the other hand, ‘future me’ cringes at the thought of dealing with a debt ceiling deadline on the morning of new year’s day in 2025. I’ll have to make a mental note to go light on the champagne that evening.
While the deal doesn’t have many facets that would immediately impact investors, I thought I’d highlight some of the major headlines from the deal:
As written before, this deal suspends the $31.4 trillion debt limit through January 1, 2025.
Non-defense spending is capped, remaining somewhat flat in 2024 and increasing by 1% in 2025.
Medical care for veterans is protected.
Roughly $28 billion in unobligated COVID-19 relief packages will be rescinded.
Work requirements are expanded for certain adults receiving food stamps.
Student loan payments will restart at the end of summer after being on pause due to COVID-19.
The creation of the Mountain Valley Pipeline, a natural gas pipeline, will be expedited.
The one area of potential near-term economic impact is related to the resumption of student loan repayments. I know this subject can trigger emotions from all sides and, believe me, the topic of student debt is one I’ve seen and experienced from every angle from borrower to financial planner to taxpayer. I have great passion for financial literacy and, based on my personal experience, think it is vital that high school students are in a position of empowerment to truly understand the financial implications of debt of ANY kind (credit card, auto, school, home, etc.). Personally, this is something I hope to focus more on in the coming years as a bit of a side project.
The reality is that, according to the Federal Reserve Bank of New York, the average student loan monthly payment is $393 (median is $222) and that 50% of student borrowers owe more than $19,291. Aggregate student loan debt in the U.S. has topped $1.6 trillion, as seen in the chart below.
What does this mean for investors? Well, it simply means that there may be less disposable income for consumers to dedicate to goods and services. As such, in the latter portion of the year, we’ll be keeping an eye on sentiment, confidence, retail sales, household debt ratios, delinquencies, and other data points that may indicate strain on consumers. For now, there’s at least some relief that aggregate prices are moderating somewhat, so we’ll touch on the inflation outlook next.
Around June of 2022, inflation – as measured by the Consumer Price Index – topped out at an eye popping 9.06% as seen in the chart below. This may help to explain why so many pundits were crying “a recession is nigh!” around this time last year, as I spoke-of in the beginning of this letter.
However, inflation has tamed somewhat since those daunting highs, coming-in at 4.9% year-over-year for the month of April. Yes, that’s closer to the 5-year average of 3.8%, but still quite a bit above the Fed’s 2% target. Economists expect to see inflation lower even further in the coming months. After all, CPI is most commonly referred-to on a year-over-year basis, so we would hope that any increases would be muted based on the elevated starting point, so we could even see CPI hit closer to 3.5% in the next month or two, only to rebound slightly in the late summer months.
Regardless, the Federal Reserve has to be pleased with where inflation is and how resilient the economy has been given the level of economic tightening. This unprecedented tightening can be seen in the staggering chart below that shows year-over-year changes in the M2 money supply.
The M2 money supply includes cash on hand, checking accounts, savings accounts, and other short-term vehicles like certificates of deposit (CDs). When the Fed wants the economy to grow, they push liquidity into the market through expansionary policies like lower interest rates and purchasing U.S. treasuries through open market operations. When the Fed wants the economy to slow down, they remove liquidity from markets by raising rates and selling U.S. Treasuries through open market operations. The chart above helps to show the tremendous amount of liquidity that had flooded markets in recent years due to fiscal & monetary stimulus, then how drastically that trend reversed as the Fed implemented its contractionary policies in early 2022.
This progress on inflation, coupled with recent commentary from Fed Chairman Jerome Powell, has led many to speculate that the Fed is currently on a ‘pause’ and will not raise the federal funds rate another 0.25% in their June meeting. While I believe the situation is still fluid, I do think that a pause is more likely than not. In previous webinars, we’ve communicated that a potential tipping point might come (and a ‘pause’ would emerge) when the effective federal funds rate exceeds inflation, and we recently achieved that dynamic as seen in the chart below.
Consensus estimates tend to agree with my outlook, and the CME Group (derivatives marketplace) provides their handy FedWatch Tool which shows a 62% chance that rates remain unchanged, as seen in the chart below.
Conversely, it should be noted that a 38% chance of a 25 bps rate hike is still meaningful, thus supporting my thesis that this situation is still somewhat fluid. After all, the next CPI report is released on June 13th while the next Federal Open Market Committee concludes on June 14th. Would a negative surprise from the CPI change the Fed’s calculations mid-meeting? We may find out.
Ultimately, over the past month, investors have eliminated a significant element of near-term uncertainty due to the debt ceiling resolution. Now all eyes turn to the Fed to see if we may see a Fed ‘pause’, which would remove some immediate uncertainty around additional Fed tightening and the subsequent effects on financial markets.
For now, much like the economy, markets have remained resilient in face of aggressive Fed policies and a worrisome banking crisis. As such, most indexes have remained range-bound in recent months with the S&P 500 up roughly +9.65%, the Dow Jones Industrial Average generally flat at +0.25%, US Bonds up +2.46%, and U.S. Treasuries up +2.35% year-to-date. Moving forward, we see some enticing opportunities emerging in bond markets that investors may have an opportunity to take advantage of. In the weeks ahead, our Destiny Capital team and I will be communicating more about that.
In the meantime, I would like to remind everyone that Jarrod Musick and I do a Markets & Economy webinar detailing some of this content every month. This webcast is roughly 30 minutes where we offer the opportunity for participants to submit questions ahead of time, or ask them in a Q&A session near the conclusion of our comments. If you’d like to attend, please keep an eye out for our monthly invitations. If you’d prefer to view the video content on your own time, the webinar is recorded and distributed the day after the webinar concludes. We’re always trying to find more effective and meaningful ways to get you the information you need to remain informed and empowered about your finances. If there is anything else we can be doing to help with this effort, please reach out to our team to let us know.
Important note and disclosure: This article is intended to be informational in nature; it should not be used as the basis for investment decisions. You should seek the advice of an investment professional who understands your particular situation before making any decisions. Investments are subject to risks, including loss of principal. Past returns are not indicative of future results.