December 4, 2023
Thanksgiving is over, December is here and the holiday season is in full swing. I’m honestly not sure where the last twelve months have gone, but it has certainly been both an eventful and fruitful year. In what follows, I’ll spend some time covering both the events and the fruits as we wrap up 2023.
As for the fruits, November was an exceptional month for financial markets. The S&P 500 gained more than 9% and core bonds rallied more than 3% practically erasing a three month string of declines. With one month left in the year, domestic stocks are up nearly 21% on a total return basis while core bonds are up more than 2%. Even a balanced portfolio constructed with 60% global equities and 40% bonds has returned more than 10% year-to-date. Fruitful.
As for the events, we’ve had our share, but fortunately many of the uncertainties faced this year have unfolded more positively than anticipated. In the first half, we navigated multiple regional bank failures and the unprecedented threat of a potential US debt default. Of course, neither evolved into a full blown crisis. Regional banking stress stabilized relatively quickly without spreading to larger banks and debt ceiling negotiations concluded with passage of the Fiscal Responsibility Act.
Following a summer of market resilience, a new set of risks weighed on the markets. In last month’s newsletter, I highlighted four converging risks that could collectively threaten continued economic expansion:
- Rising oil and gas prices
- A potential government shutdown
- Resumption of student loan repayments
- United Auto Workers (UAW) strike
We noted that these concerns had the potential to hamper fourth quarter growth and the outlook for 2024 by a little, or a lot, depending on the extent of the combined fallout. One by one, each risk evolved favorably. Oil and gas prices, which raced higher throughout the third quarter, have pulled back sharply thus far in the fourth quarter. We’ve avoided a government shutdown twice now with the can currently kicked down the road to February 2024. Student loan repayments did resume, as expected, but this dynamic has been factored into forecasts for months. The October retail sales report did not show a significant aggregate impact from the resumption of student loan payments and came in stronger than consensus forecasts. Additionally, consumer spending appears healthy as initial estimates from Adobe Analytics show e-commerce transactions for Black Friday and Cyber Monday up 7.5% & 9.7%, respectively, over 2022. Lastly, the UAW strike concluded with successful contract negotiations after just six weeks of limited strikes.
As a result of these outcomes and other factors, the outlook for real US GDP growth has continued to improve. As has been the case throughout 2023, the expected economic valley has gotten shallower and pushed further into the future. Entering Q3, the median economist forecasted 0% real growth for Q3 and a 0.5% decline for Q4. However, the economy actually expanded 5.2% in Q3 and is forecast to grow 1.1% in Q4 (all figures are presented as quarter-over-quarter Seasonally Adjusted Annualized Growth Rates). Based on current projections, the near-term “low” point in the current cycle is forecast to hit in the second quarter of 2024 with growth of 0.2%. Again, this growth valley is shallower and further in the future than a month ago when forecasts pointed to 0.2% growth in the first quarter of 2024 as the near-term low point.
After an unexpected surge in September, US hiring cooled by more than expected in October and the unemployment rate inched slightly higher. The US labor market added 150K jobs, the unemployment rate increased to 3.9%, and wages grew slightly less than expected. In 2023, US employment has grown by an average of 240K per month, moderating from the 2022 average of 400K per month. Importantly, there are signs that the labor market is coming into better balance as total job openings have declined by 2.5 million since early 2022. The ratio of job openings to unemployed workers stands at 1.5:1, down from a peak of 2:1. This is welcome news for the Fed which is aiming to reduce wage pressures without a meaningful spike in the unemployment rate.
Turning to inflation, October data reported in November showed the Consumer Price Index (CPI) rose at 3.2% (year-over-year), decelerating from 3.7% in September and coming in below expectations of 3.3%. While this outcome remains above the Fed’s stated target of 2.0%, it highlights significant improvement from the June 2022 peak of 9.1%. At +6.7% year-over-year, shelter costs decelerated slightly from +7.2% in September and a peak of 8.2% in March. We continue to keep a close eye on shelter costs, which represent nearly one third of the CPI basket and tend to impact the index with a lag.
Inflation has decelerated significantly and the labor market has softened without falling off of a cliff. While the monetary policy making environment remains tenuous, these are positive developments for the Fed.
On November 1, policymakers maintained the Federal Funds Rate target at 5.25%-5.50%, as expected.
The most recent Fed projections from September anticipate one additional rate increase this year, though an additional hike appears unlikely to us. Instead, it seems plausible that we have reached the peak of this hiking cycle, prompting consideration of when we might anticipate interest rate cuts. While markets are pricing in cuts beginning with the May 2024 meeting, minutes from the most recent FOMC meeting showed no indications that Fed officials were considering rate cuts in the near term. Committee members agreed that Fed policies need to stay “restrictive” until data shows a convincing trend that inflation will return to the central bank’s 2% target.
We will continue to monitor headline events and economic health in the fourth quarter and look forward to sharing our perspective as the narrative evolves. As always, we encourage investors to lean on discipline and the benefit of a long time horizon during periods of uncertainty. On behalf of the entire team, thank you for allowing us to serve on your behalf.