As we move toward the end of the year and into the next, there are any number of issues (as always) that could produce concern for investors. The prospect of a government shutdown, a looming Presidential election in 2024, wars and oil prices to name a few. But this is nothing new to those of us that have been around markets for a while. In fact, if things ever seem entirely under control, I’d begin to really worry. At Atlas, we try intently to keep our eyes focused on markets, to not be triggered by headlines, looking for those true factors that drive asset prices so that we can make prudent investment decisions.
We in the Portfolio Management Group at Atlas track countless economic data points and financial reports in an attempt to divine the future of the markets. To varying degrees, all market participants do this. Experienced market analysts know that as things change, it is frequently better to focus on the direction and rate of change as opposed to concentrating on the actual numbers themselves. They also know how to think in terms of the second order; in essence understanding a first reaction in the market to something, but asking themselves “Then what?” In this piece I’ll try to provide some of our perspective in this area, for absorbing the financial news in a slowing economy.
TAKING THE HEADLINES WITH A GRAIN OF SALT
At the risk of seeming cynical, I’d like to mention some things that I consider when viewing the reporting of economic events by popular media outlets. Most media outlets depend on increasing viewer numbers (also known in this digital age as “eyeballs”) to help them sell advertising to fund their business. For advertisers, the access to eyeballs drives their ad spending. Predominantly in social media, but to an extent also in mainstream media, computer algorithms determine what content viewers are presented with based on their engagement trends, and in doing so often pushes a stream of similar content over time. This is a coarse generalization to be sure, however it does reflect the methodology used by many major distributors of media content.
It has become clear to marketers over the past several years that shock tactics or “triggers” attract eyeballs. In my life I can remember a time when sensational headlines were restricted to the “gossip papers” found on the rack near grocery store checkouts. Alas, we now see similar headlines and articles in “mainstream” media publications. So, increasingly the competition for eyeballs appears to be driving the type, quality and accuracy of editorial content, if not the entire methodology of programming and distribution. Unfortunately, much of the content, generated to appeal to targeted viewers, is misleading at best and deceptive at worst.
Since March of 2022, the Federal Open Market Committee (the Fed) has been involved with the largest and fastest series of rate hikes in its history. As we know, these hikes are intended to slow economic output in order to battle inflation. But the economy has remained strong through this cycle. We think that as this year progresses into 2024, the impacts (otherwise known as “long and variable lags”) of these rate hikes on the economy will become an increasingly important topic, garnering a great deal of attention in the media.
People spend a great deal of time focusing on the Fed and what they might do next. While we deal with what the Fed is doing, we spend less time worrying about what the next meeting might bring and instead try to discern what direction they’re going, and importantly when that might change. So, for us the focus is less on when the next rate hike might come and how much it will be, but rather on when they might pivot toward rate cuts. As of the time of this writing, it appears to us that this might take place sometime around mid-2024, but that could change. Further, we think that the markets will begin to price a more stimulative monetary policy well in advance of that event.
STEPPING BACK FOR A BETTER VIEW
A question we’re regularly asked these days is “Do you think we’re heading toward recession?” At the moment, we think there is a chance of a recession, but that it will not be of the kind that disrupts the country as much as some appear to fear (more on this below).
For recession watchers, periodically it’s a good idea to try and take a few steps back to “see the forest for the trees.” After months of watching and waiting for signs of the next recession (which many predicted to arrive sometime in 2023), the idea of taking a step back was expressed by one of our Portfolio Management Group associates, Phil Estes, who commented, “If the consumer is healthy, then nothing else matters. If they’re not, then it all matters.”
SO WHAT MATTERS?
To start, we think that there are a few very important things to watch presently to get a genuine view of where the economy is heading.
First and foremost is the consumer. Why? Because the consumer is responsible for a large part of U.S. economic activity. According to CEIC Data private consumption in the U.S. accounted for 68.3% of Gross Domestic Product (GDP) in June1. Over the last 10 years the consumer has consistently accounted for over 2/3 of GDP1. As a result, as implied by Phil, to the extent that the consumer remains healthy we can remain confident in the health of a sizable portion of U.S. economic output and GDP growth.
Closely tied to the health of consumer is overall household debt. Clearly, (and with other things remaining equal) as debt rises spending capacity shrinks.
Last but not least is the housing market. For many Americans, a substantial share of their net worth is in the equity of their home. The potential impact of this on consumer behavior via the “wealth effect” is considerable (the wealth effect is a behavioral economic theory suggesting that people spend more as the value of their assets rise2.) Therefore, when real estate prices are rising, we as consumers tend to spend more.
WHERE DO WE STAND?
At present, conditions for consumers appear stable, but the outlook is mixed. While strategists generally are sanguine about rates of consumer spending, questions about the impact of inflation on holiday spending are quite reasonable. Other factors such as the effect of a resumption of student loan repayments could negatively impact spending in the future. That said, the rate of employment is key factor in consumerism. Currently, the unemployment rate stands at 3.8%3, with employment almost as strong as it has ever been. When people are working, they’re apt to spend more. This has held true recently, as through the summer consumer spending continued to accelerate.
And this is where alarming headlines can mislead. It was reported in August4 that consumer credit card debt hit $1 trillion for the first time. This was reported by many news outlets, ringing alarm bells over the specter of what dire consequence this level of debt might signal. Most every article we saw expressed doom and gloom. What was not reported is that overall household debt is in a long-term downtrend, down from a peak of 90.21% of GDP in 2011 to 73.05% in the 1st quarter of 20235. So, is debt a significant challenge to consumer spending? We think that as long as people are working, it’s a diminishing issue. At 3.8% unemployment, a lot of people are working and there seem to be few indications that the consumer has been impacted as much as might have been predicted a year ago.
So, while the dollar value of credit card debt provides a juicy headline, the underlying reality is that credit card debt appears to be growing at a rate less than that of the overall economy. For a reporter, that’s a little less interesting headline.
The housing market is, perhaps, a more challenging issue. The positive contention is that many Americans were able to refinance their mortgages to fixed rate terms when interest rates were quite low. To a large extent this insulates them from the effect of rising interest rates. In his press conference following the September 20 FOMC meeting, Fed Chairmen Powell stated that the housing market has improved. Perhaps over the last month or two, but inventories remain very tight, and affordability is strained perhaps more that it has been in over 30 years. For newer entrants to the housing market, things are quite challenging. With higher interest rates and inventories at record low levels, buyers have few options but to pay up, in both price and mortgage rate. To the extent that a correction is avoidable in the real estate market, things continue to look positive as it affects consumer spending, but only time will tell how this may play out.
At this time we are anticipating a slowdown in the economy, perhaps led by housing, that could pave the way for a Fed pivot toward lowering overnight lending rates sometime in 2024. While we continue to half to the idea of rolling “mini recessions” from sector to sector, we think that a general, widespread economic contraction is less than a 50% probability. It is important to point out that we think markets will begin to respond to the prospect of lowered lending rates well in advance of the release.
As always, we continue to monitor the data and seek to make prudent and informed adjustments to our portfolios. If you have any questions about this, or any other financial issue, please feel free to contact your Atlas Wealth Management Advisor. We remain ready to assist you in your journey toward achieving your financial goals.
We hope that you are enjoying the autumn, and looking forward to a happy, healthy and rewarding holiday season.
Footnotes and Sources