The economic backdrop thus far in 2023 has once again brought to light a powerful and recurring reminder we must all acknowledge. Simply because the masses expect something to happen is not a reason for it to occur. Such a statement provides context to the recessionary outcomes that were largely predicted heading into 2023 amidst a tightening monetary policy backdrop. Such a strategy was designed to battle inflation through higher interest rates and higher unemployment, a path that the Federal Reserve continues to appropriately pursue. The perceived certainty of such an expectation, however, caused most investors to enter the year with a cautionary mindset toward equity market participation and a rather somber tone toward consumer health and consumption. The reality has proved notably different, and it bears significance to recognize the changes and appropriately pivot, albeit marginally.
It's important (and fair) to note that when we released our own "View of 2023" in December of last year, we indicated that a “mild-to-normal recession is likely to occur in 2023." Our stance was built on tight monetary policy actions amidst the potential for a normalizing labor market and muted fiscal policy drag. Our main takeaway, however, was centered on the fact that any form of a recession, “would be indicative of a lagging announcement amidst a likely already recovering economic backdrop." We remain objectively convicted in our stance and continue to favor equity market participation, yet we no longer adamantly believe a recession is capable of maturing in 2023.
Although we continue to foresee a tight Federal Reserve over the next six months, it remains exceedingly difficult to make the argument that monetary policy is negatively impacting the labor market in the short term. January’s private payrolls were a strong testament to such a claim, and we have yet to truly witness the lagging impact that higher interest rates can have on jobless claims. This isn’t to suggest that higher interest rates are not impacting the economy in any capacity, because that would not be accurate, but higher interest rates have yet to curtail spending and consumption in what would be perceived as appropriate by the Federal Reserve. As a result of that, our belief is that interest rates are likely to remain marginally higher through year-end alongside a neutral equity market that carries the possibility of a high single-digit return.
As we further unpack the current environment from an earnings standpoint, the backdrop is revealing a less dismal reality relative to initial expectations. This is not to suggest that earnings will yield abnormally strong results for the year, but it does showcase the current resilience of the aggregate consumer base. Such resilience is not only evident in the neutral earnings backdrop, but it can also be traced via the transportation and demand of goods, easing supply chains, and an overall wage growth backdrop that has increased (although not high enough relative to current inflationary data). Through the date of this commentary, roughly 70% of S&P 500 companies have released earnings for the quarter and, the aggregate sales growth remains at 5.34% (earnings growth has declined by a mere -2.36%, which is better than initial expectations). What’s most interesting in the earnings data is the fact that the Consumer Discretionary sector has posted a 13.36% sales growth amidst a 22.32% earnings growth. Those are not figures that resemble an upcoming recession, and they provide an actionable understanding of consumers’ responses to higher prices.
As a result of the updated data backdrop, our view is that the prospects for a recession in 2023 have decreased, and the recessionary pressures tied to early 2024 have increased. The notion of “kicking the can down the road” carries tremendous context because the eventual impact of higher interest rates will be visible, yet the timeline seems slightly dimmer. The lagging impact of higher interest rates to a slowing labor market is not up for debate – it will happen. The hope is that the Federal Reserve appropriately manages inflationary expectations relative to their mandate of slowing the economy and does so without triggering mass layoffs.
We continue to believe that a potential recession 12 months from now will likely carry the same soft landing undertone given the absence of systemic and prudential risks to the economy. This may also result in a positive outcome for equity markets in 2023, especially under a scenario of muted inflationary pressures beyond current levels.
Investment advice offered through CX Institutional, a registered investment advisor.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The economic forecasts set forth in the presentation may not develop as predicted.
All return data sourced from Bloomberg. All other data soured from Bloomberg, through the release of monthly figures from the Department of Labor, Bureau of Economic/Labor Statistics, U.S. Census Bureau, or from the Federal Reserve and any of its affiliated regional locations. Small Business Optimism sourced through NFIB. Small business hiring plans sourced through NFIB. Consumer sentiment sourced through the University of Michigan. Earnings data sourced through Bloomberg Intelligence and through Bloomberg’ earnings analysis composites. Interest rate cut/rise probabilities are sourced from Bloomberg’s tracking of futures contracts tied to the Federal Funds interest rate.