The Resilience Continues
Despite numerous forecasts of impending recession, the U.S. economy continues to grow. Second quarter GDP performance is now in the books with a reading of 2.1% which was virtually equal to the 2.0% level generated in the first quarter. In a few weeks we will get the initial estimate of GDP for the third quarter and according to FactSet Economics the result will reveal a growth rate of 2.5%. Interestingly, there are numerous economists that are projecting even stronger growth for the third quarter with estimates as high as 3.5% and the GDPNow estimate from the Federal Reserve Bank of Atlanta currently registers an even higher estimate of 4.9%.
One of the key contributors to the ongoing growth of the U.S. economy has been the consistent firmness seen in the labor market. The unemployment rate continues to register monthly readings under 4.0% and growth in non-farm payrolls, while exhibiting an increasing moderation, have not rolled over. In fact, over the past six months the increase in non-farm payrolls has averaged 233,000. Another metric of employment, Initial Jobless claims continues to point toward stability on the labor front as the weekly measure has declined from a recent peak of 265,000 on June 16 to the most recent reading as of Sept. 29 which registered 207,000.
There are other measures of economic activity which have been holding up well in addition to employment. Construction spending has advanced 7.4% on a year-over-year basis as of August. One area of construction that has been somewhat surprising thus far in 2023 is new homes. With affordability at an extremely low level given higher mortgage rates and stubbornly high home prices new home sales have staged an impressive recovery from the steep decline seen in early 2022. Some of the momentum behind this recovery is due in part to the poor level of affordability. The rapid rise in mortgage rates has led many owners to stay put in their existing homes rather than give up the extremely attractive mortgage rates they have been able to lock in over the past few years. In fact, it is estimated that 90% of home mortgages in the U.S. are under a rate of 5%. So, for prospective homeowners the new home route has been the more viable alternative. This sentiment is confirmed by real estate firm Redfin, which reports that the supply of homes for sale in the U.S. as of August was down 17.5% from the prior year which supports the focus on newly constructed homes.
Wage growth has also been a positive of the economy with year-over-year increases exceeding 4.0%, a pace that has been in place for over two years. In looking at wage growth over the past 10 years the current rate of growth was never achieved prior to the pandemic.
With stable employment, wage growth and construction strength the first half GDP results and the expectation for the third quarter reflect an economy that does not appear to be on the brink of a recession.
Not Out of The Woods Yet
While the previous section described a U.S. economy demonstrating consistent growth a look into the future does not exclude the possibility of recession. While numerous indicators point to strength and stability there are numerous others indicating prospective weakness. Rather than providing an extensive list of these indicators we will focus on one component of the financial market landscape having a meaningful impact on whether the economy falls into recession at some point.
The attribute being referred to is interest rates and the key driver of interest rates, specifically short-term interest rates, is the Federal Reserve (Fed). To the degree the Fed has to maintain its “higher-for-longer” inflation fighting policy regarding interest rate levels the greater the impact these higher rates will have on the economy. It can take up to two years from the inception of the Fed’s tightening of monetary policy to lead to a weakening of employment. And if a meaningful decline in employment occurs a recession may well ensue. We will be monitoring future economic data releases to determine the effectiveness of the Fed’s policies and their impact on the economy.
Asset Allocation Overview
Given the negative returns for financial assets in the third quarter each of our seven investment objectives also experienced a negative result for the period. Interestingly the return differential across the spectrum of stocks and bonds was narrow as fixed income exhibited the least negative return at -3.2% while the weakest performer was foreign equities which had a return of -3.8% for the quarter. Fixed income has experienced significant vacillation in its performance as of late as the past two quarters have delivered negative returns, but the past twelve months still yields a positive result.
We continue to maintain our current neutral positioning across each of our seven investment objectives. We feel that the level of uncertainty pertaining to the economy and financial markets warrants this strategy. Over the past several months we have been bombarded by forecasts of recession, or of a soft economic landing or no landing at all. The current outlook is for the rate of economic growth to slow over the next couple of quarters while 2024 earnings expectations for U.S. equities is in the double digits. As previously stated, there are a plethora of mixed signals. Therefore, our current focus will be on working from the inside out. To translate, this refers to concentrating on the various underlying components within the financial
markets as opposed to looking to a grand overarching scheme involving significant allocation shifts across major asset classes.
We typically end this section of our newsletter with a reminder for investors to review their current investment objectives to ensure they are in alignment with the goals they are striving to achieve. Given the substantial rise in interest rates this review takes on an even higher level of importance as we have experienced a migration from T.I.N.A. (there is no alternative) to T.A.R.A. (there are real alternatives). The T.I.N.A. acronym was created when interest rates were extremely low and reflected an environment where fixed income represented little competition for equities. We have now evolved to T.A.R.A. which communicates that meaningful investment opportunity is available in addition to the equity markets. This currently applies specifically to fixed income which has seen a significant increase in yields. Our suggestion is not necessarily a call to action but a call for awareness for investors to be cognizant of their current objective and risk tolerance in light of the current investment environment and the congruence of their objective with this environment.
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.