Three Driving Factors of the Economy We Are Watching Heading into Q4 2023.
HWM Market Recap - November 2023
Executive Market Summary
So, how's the economy doing? Well, it's been a mixed bag. What was a tight labor market is easing, inflation slowed enough to avoid another interest rate hike from the Federal Reserve, and last quarter saw a nearly 5% annualized growth rate for the gross domestic product (which is the strongest we've seen since late 2021). Many economists are surfacing, saying that the Fed's quest for a soft landing is upon us – to see more about our take on the hard vs. soft landing debate, check out our August newsletter. While we cannot completely rule out that the Fed could execute the widely hoped-for soft landing (no recession) outcome, our analysis shows that the odds are not in that scenario's favor. With that in mind, the three driving factors of the economy we are paying attention to right now are general business optimism, Consumer Sentiment, and the housing market.
Small business owners continue to feel pressure from several factors, including inflation, labor availability, and the future economic outlook. Moreover, as small businesses often require capital to grow and, therefore, must borrow money, they are particularly affected by high interest rates and banks restricting the amounts they are lending. The National Federation of Independent Businesses (NFIB) publishes multiple notable statistics about sentiment from small business owners. One of which includes the NFIB asking its members about their outlook for the economy over the next six months. This index has remained near record lows for the last year and a half.
Consumer Sentiment is also a crucial indicator we watch as its recent rebound appears to be losing momentum. Sentiment and expectations are often essential to follow because they influence how and if people invest. Because of this, negative sentiment can be a self-fulfilling prophecy. Both sentiment about current economic conditions and future expectations were down significantly. As shown in the University of Michigan's Index of Consumer Sentiment, the decline was largely driven "by higher-income consumers and those with sizable stock holdings, consistent with recent weakness in" the stock market. Moreover, inflation expectations rose, projected business conditions plunged, and consumers' expectations about their finances for the year to come dropped. This points to ongoing concerns about inflation and potential uncertainty over the implications of troubling news domestically and internationally.
The housing market also finds itself in a difficult position and, in many areas, has practically ground to a halt. The National Association of Home Builders (NAHB) Housing Market Index, which tracks homebuilder confidence, is again falling, indicating a weaker outlook and demonstrating the rippling effects housing is feeling from rising interest rates. To combat this, builders and mortgage companies have tried to lure in buyers and spur activity by offering temporary relief for the first few years of the mortgage through incentives. Moreover, individuals with lower interest rates on their mortgages continue to hold onto their properties. At the same time, many recent homebuyers are counting on rates dropping soon so they can refinance. We also see that many additional variable costs associated with owning a home are rising including property taxes and homeowners insurance premiums even in places outside of high-risk areas such as California and Florida. Couple all this with the fact that home prices have surged over the last five years, leading us to one of the most challenging times in U.S. history to afford a home.
Our safety-first investment philosophy means staying a step ahead, not forecasting. Most investors today, with few exceptions, have only seen interest rates that were declining, ultra-low, or both. To see prolonged periods that were otherwise, you would need to have been investing for more than forty years and thus be over 65. Therefore, it is easy to conclude that investors today assumed that the interest rate trends of 2009-21 were normal due to the scarcity of veteran investors from the 1970s.
With bond yields so low during those 13 years, it was challenging to safely and dependably get high total return in investment portfolios without taking on more risk than was prudent for that investor. The options were:
Hold those bonds and accept the reality of the lower yields,
Reduce risk to prepare for an impending correction which was bound to happen due to the strong demand for higher returns in bonds, or
Take on more risk in pursuit of higher growth.
Today, with elevated inflation lingering, yields on 10-year Treasury Notes have escalated to a 16-year high. It seems as though investors are coming to terms with the Fed's "higher for longer" stance regarding interest rates. Therefore, stocks may have a tough time rebounding – in particular, the higher the 10-year yield goes, the lower stocks could go. At least this has rung true since August.
The bottom line is that despite a strong rebound this year in stocks, we have remained defensive in our strategy. Plenty of the macroeconomic indicators we follow encourage us to stay cautious, which is what we plan on doing. In the meantime, we are keeping a healthy portion of portfolios in cash and cash equivalent securities (like money market funds, treasury bills, and CDs) that provide not only safety but yields at 16-year highs while the market works through the current elevated risk environment.
Monthly Changes in Indices
Year-to-Date Changes in Indices
Monthly Performance By Sector
Year-to-Date Sector Performance
News Influencing the Economy
As described in last month's newsletter, we expected inflation to ease from its high levels, but we also anticipated it would remain higher than the market would like. After dropping to 3.0% year-over-year, the Consumer Price Index (CPI) has increased for three consecutive months. The CPI rose 0.4% in September (4.8% projected annually) after increasing by 0.6% in August (7.2% projected annually). Over the last twelve months, the index increased 3.7%. The Core CPI (which excludes food and energy prices) rose 0.3% in September (3.6% projected annually), the same core increase as in August.
The Personal Consumption Expenditures Price Index (PCE, and the Fed's preferred index to track inflation) rose by 0.7% month-over-month in September (8.4% projected annually), or 0.4% when adjusted for inflation (4.8% projected annually). Over the last twelve months, the index rose 3.4%. Meanwhile, Personal Income rose only 0.3% at a monthly rate (3.6% projected annually).
The Federal Reserve left the Federal Funds rate unchanged at, what the Wall Street Journal characterizes as, a 22-year high. This marks the second consecutive meeting the Fed skipped changing interest rates.
Mortgage rates continue to climb toward 8%. As of October 26th, the average rate on a 30-year fixed rate mortgage is 7.79%, up from 7.08% one year ago and 7.31% at the end of last month.
After a three-year moratorium ended in October, 43 million borrowers were required to start paying back their federal student loan repayments. As a result, up to $100 billion in consumer spending could be diverted from Americans' pockets over the next year.
The United Auto Workers Union (UAW) reached a tentative deal with General Motors, the last holdout after fellow car manufacturers Ford and Stellantis had already reached tentative agreements with the union. This ends the six-week strike, which GM said was costing it $200 million per week.
In similar news, Kaiser Permanente reached a tentative deal with the unions representing 75,000 of its employees, marking the end of the largest healthcare strike ever in U.S. history.
According to the Job Openings and Labor Turnover Survey (JOLTS), employers reported having about 9.6 million job openings at the end of August, up 690,000 from July. Employers added 150,000 jobs in October, and the unemployment rate had little change month-over-month at 3.9%.
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Holzberg Wealth Management is a family-owned and operated financial planning and investment management firm based in Marin County, CA. As your financial advisors, we serve you as a fiduciary and are fee-only, so we never receive commissions of any kind. We help individuals and families like you in the greater San Francisco Bay Area and virtually nationwide with the financial decision-making process to organize, grow, and protect your assets.
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