And the roller coaster continues… Earlier this year, we suggested that we are likely to see a choppy market with a lot of ups and downs. Outside of a handful of technology names this has largely born out through the first three quarters of the year. Through July, we saw a decent run up in growth sectors of the stock market, while that has largely stalled since. Value positions and fixed income areas have continued to face headwinds as the Federal Reserve has continued interest rate increases throughout the year, with the most recent hike coming in July. The big question remains: how far will the Fed go before ending rate hikes for this cycle?
When the year started, most economists and much of the financial media predicted recession this year. As the year has progressed, we have seen the economy outperform these expectations, and many economists and the media have pulled back on recession calls and adjusted to a rosier outlook.
We believe the reason for this change in outlook is related to the continued strength in the job market and the consumer generally. The continuance of pandemic era government support as well as the large subsidies included in the CHIPS Act and Inflation Reduction Act are also driving short term performance. These subsidies are by certain accounts more than 3 times as large as they were estimated while the bills were under consideration. The below chart helps to illustrate the magnitude of change in construction spending alone.
Much of this spending is in the computer, electronic, and electrical manufacturing sector, particularly semiconductor plants. Other areas of the economy will also be receiving large subsidies, particularly in areas considered “green” energy.
For the long-term health of the economy, the focus on politically favored subsidies for a few select sectors raises concerns about sustainability. Massive subsidies for sectors that do not make market sense in the absence of subsidies begs the question of how that will be supported long-term or when the political winds change direction. While the government spending directly helps GDP in the short run, it also contributes to inflation and begs the question of what happens to those sectors if the government at some future point discontinues its support—i.e. self-sutainability.
And while this has provided a boost to growth in the short-term, there are still a number of signs that point towards a slowdown coming. To start, the treasury yield curve has been inverted for one of the longest periods of time in history. This is typically considered a strong recessionary signal. Bank lending has tightened significantly since the start of the year. Average monthly job growth has continued to decline. Consumers are dipping more into their savings and the most recent Personal Saving Rate for August came in at 3.9%, which is lower than pre-pandemic and down from much higher peaks around the pandemic. This signals more pressure on family budgets. We also have student loan repayments starting again after 3+ years of nonpayment. Labor strikes are affecting a number of industries due to unhappiness with employment conditions and the effects of inflation on wages. This includes the auto sector, entertainment, and potentially others. On top of this, we have a torrid pace of new regulations coming out of the federal government which will start to weigh on various sectors and consumers as they come fully online, for those not struck down by the courts. The federal government is also struggling to get to a compromise on spending, and thus the prospect of a partial government shutdown, and short term negative economic effects are rising.
In light of the contradictions we’re still seeing in the economy, we believe it is still prudent to maintain caution. We will be continuing to focus on sectors we believe bring value, pay strong yields, and reinvest during this choppy market.