If there is one word that could be used to describe the performance of the U.S. economy over the first half of 2023, it would be resilient. For months we have been bombarded by assessments that project imminent recession. And, as we have seen, those predictions have thus far failed to materialize. Indicative of the economy’s resilience was the final reading of first quarter GDP. The consensus estimate for economic activity was 1.3% for the period but the final reading registered a significantly stronger level of 2.0%. One of the key contributors to the higher level was an increase in first quarter consumer spending. And given that consumption represents approximately two-thirds of GDP in the U.S. a strong level of consumer spending translates into positive economic growth.
Two key contributors helped drive consumer strength in the first quarter. The first being the ongoing strength in the labor market, evidenced by the low rate of unemployment, continuing growth in nonfarm payrolls and the current number of available jobs as indicated by the JOLTS survey. Also, in its most recent release the JOLTS quit rate rose to 2.6% from a previous reading of
2.4%. The quit rate measures the number of people who quit their jobs each month and then expresses that number as a percent of total employment. While this figure has moderated since it first hit 3.0% in November 2021 it is still higher than pre-pandemic levels. When citizens with jobs are willing to
leave their current employer to find another job, they are comfortable spending their wages on goods and services.
The second key contributor is the money distributed to citizens by the government through pandemic related programs. The ability and willingness to spend these funds is reflected in new vehicle sales which have risen to an annual level exceeding 15 million compared to the 13.37 million level in December 2022. New home sales have also been robust as the annualized rate for this measure hit 763,000 compared to the recent trough level of 543,000 in July 2022. Existing home sales have also increased over the first half of 2023. However, their growth has not been as substantial as new homes sales as many existing homeowners are reluctant to sell and trade in their lower mortgage rate for a now higher mortgage rate.
The Look Forward
For the quarter just ended the expected rate of GDP growth is 1.0 – 2.0%. The factors contributing to the results for the first quarter are anticipated to continue into the second quarter. As for the second half of 2023 the consensus view is for the pace of economic growth to slow to readings that are slightly above or below zero. We concur with that outlook for two primary reasons.
First, one source of consumer strength has been the aforementioned government funds received through pandemic related programs. The final dollars received from these programs is anticipated to be exhausted in a few months.
Second, the Federal Reserve (Fed) has signaled that it may raise the Fed Funds rate two more times this year. While rate increases would be positive for savers, they would negatively impact borrowers creating additional friction for consumers purchasing homes or cars and for businesses looking to finance current operations or expansion opportunities. And given the lag that occurs between when rates are increased and when their full impact flows through the economy, we may not have seen how the higher rates already in place will influence future growth. And more specifically, the impact of higher rates on employment may lead to a higher rate of unemployment thereby weakening the consumer.
We still do not anticipate that the U.S. economy will fall into recession this year but additional rate increases will certainly increase the odds of one developing.
Asset Allocation Overview
The strong performance of equities in the second quarter led the overwhelming majority of our allocations to positive returns for the period. The lone exception to these results was the Income allocation which did have a negative return given its total commitment to fixed income. And despite the weakness in the second quarter the Income allocation still maintains a positive year-to-date return.
We continue to maintain our neutral positioning across each of our objectives. Well documented growth stocks have overwhelmingly outperformed value stocks year-to-date. Market leadership has actually been limited to a small number of stocks within the growth universe. Given the magnitude of the move in these stocks we anticipate a broadening of the market for which our neutral positioning is appropriate. Interestingly, one year ago we would have been discussing a market environment totally opposite to what we have seen in the first half of 2023. That period saw equity returns that were deeply negative for the six-month period but had value stocks clearly in the leadership role relative to their growth brethren.
Our neutral positioning also applies to small cap domestic equities as well as the stocks of companies outside the U.S. Both of these market segments have underperformed large cap domestic equities year-to-date and at this time we do not feel compelled to move them away from their neutral status. It is often cited that international markets have a more modest valuation than domestic markets but that has not been a sufficient catalyst to date to lead us away from our current positioning. In regard to small cap stocks we feel valuation levels are attractive but if monetary policy becomes more restrictive and liquidity is drained from the system small cap stocks will have a meaningful headwind with which to contend.
As always, we encourage investors to review their investment objectives to ensure they reflect their goals and risk tolerances.
The information provided has been obtained from sources deemed reliable, but BTC Capital Management and its affiliates cannot guarantee accuracy. Past performance is not a guarantee of future returns. Performance over periods exceeding 12 months has been annualized.
This content is provided for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Statements in this report are based on the views of BTC Capital Management and on information available at the time this report was prepared. Rates are subject to change based on market and/or other conditions without notice. This commentary contains no investment recommendations and should not be interpreted as investment, tax, legal, and/or financial planning advice. All investments involve risk, including the possible loss of principal. Investments are not FDIC insured and may lose value.