Mid-Year Outlook
The United States economy has moved into a phase that can be described as “bending, but not breaking.” With first quarter real Gross Domestic Product (GDP) registering a growth rate of 1.4%, the second quarter is forecast to accelerate to 2% before moderating to 1.6% for both the third and fourth quarters. Hence, the use of the “bending, but not breaking” descriptor. Another apt descriptor would be “weakening, but not weak.” The resulting outlook described by this phraseology indicates a recession continues to be a relatively remote development which is not anticipated at this time. To highlight this viewpoint the survey of economists conducted regularly by Bloomberg shows a current probability of recession over the next 12 months of only 30%.
Our economic outlook continues to focus intently on two crucial variables: inflation and employment. Over the past year, we have consistently stated that a recession was not a high probability event due in large part to the ongoing strength in the labor market. When jobs are plentiful and wages are growing, it is difficult to see how a recession evolves in an economy where approximately 70% of its growth is attributed to consumer spending. While we have seen some weakening on the labor front, it still cannot be defined as weak. The unemployment rate has just recently risen above 4%, and job openings, as measured by the Job Openings and Labor Turnover Survey (JOLTS), have materially declined from the high point in March 2022 when JOLTS registered 12 million job openings versus its latest reading of just over eight million. The current level, while meaningfully below its recent high, is materially above its pre-pandemic level. Also, initial claims for unemployment have been trending higher but are in line with the levels seen a year ago at this time.
On the inflation front we have seen tremendous progress made as inflation has decelerated significantly as evidenced by the decline in the Consumer Price Index (CPI) from its year-over-year (YOY) high level of 9.1% in June 2022 to the most recent reading of 3.3%. As we have stated numerous times over the past several months, there will continue to be resistance to further declines, but we anticipate they will occur. The longer-term outlook for inflation via the Federal Reserve Bank of St. Louis’ 5-Year, 5-Year Forward Inflation Expectation Rate measure points to modest future readings as it currently indicates a five-year average rate of inflation of 2.32% for the period starting five years from today.
Realization of this scenario would likely result in a Federal Reserve that could start the process of reducing the Fed Funds rate prior to year-end. Financial markets concur with this outlook as they are currently assigning a probability of 70% for an initial cut to occur in September. They also project a second cut that will occur in December.
Asset Allocation Overview
Equities continued their move higher in the second quarter as the Russell 1000 Index of domestic stocks returned 3.6% for the period. The Standard & Poor’s 500 Index, a somewhat narrower barometer of United States equity market performance, returned an even higher 4.3%. International equities also moved higher with the MSCI ACWI ex USA Index offering a more modest result of 1.1%. On the fixed income front, quarterly returns were essentially flat with major indices registering results that were slightly above zero. Another asset class that deserves mention regarding performance is cash, or more specifically, cash equivalents. Money market funds that invest in cash equivalent vehicles, continue to have numerous offerings yielding 5% or more. Given the positive returns from equities, bonds and cash equivalents, all seven of our strategic asset allocation benchmarks also recorded positive results for the quarter.
For each of our seven investment objectives we maintained our neutral asset allocation positioning relative to their respective strategic benchmarks. Our Asset Allocation Committee continues to meet regularly and evaluate potential alterations to our various objective allocations, as well as alternative asset classes. To date, we have not developed sufficient conviction on either of these fronts to commit to a meaningful move away from our neutral stance.
Returns generated by large cap domestic equities have provided continued support for the maintenance of our neutral positioning as it continues to be the dominant asset class in return generation in terms of both near-term and long-term time periods.
Our commitment to our current fixed income allocations has been reviewed thoroughly and given the potential for the Fed to cut short-term interest rates prior to year-end has led us to maintain our positioning. While international equities have appeal on a valuation basis, the growth anticipated from this market segment continues to lag that of the United States.
As stated earlier, we continue to monitor the economy and financial markets in our ongoing evaluation of our current positioning, as well as potential opportunities by changes to that positioning in the form of a change to our current asset class allocations or the introduction of alternative asset classes.
In closing, we encourage investors to conduct an evaluation of their own regarding their current investment objective to determine if it still reflects their goals, time horizon and level of risk tolerance.
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.