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Q3 2023 Market Perspective

We began the year by focusing on a few key themes:

  • Inflation

  • The Federal Reserve's interest rate hikes

  • The potential impact of a recession

Many economists predicted a slow start to the year followed by a stronger second half. However, we experienced a solid first half of the year, and the economy has proven to be highly resilient despite facing these challenges: banking crisis, debt ceiling crisis, persistent inflation, and rate hikes. We are seeing signs of improvement, and inflation has dropped from 9.1% in June 2022 to 3% in June 2023. Unemployment rates have remained low, and companies have prioritized labor over profitability. The Federal Reserve is watching the unemployment and labor markets data to see if they can create upward inflation pressure. We are expecting two more rate hikes before year-end. Leading economic indicators are pointing towards a potential recession, with 14 consecutive months of decline. However, no one knows the exact timing of it, but Goldman Sachs Chief Economist Jay Hatzius's latest recession probability was revised from 25% to 20% in the next 12 months. Economic growth is expected to slow down as we enter the year's second half. There is continued uncertainty surrounding these challenges and their potential economic impact. Monitoring these factors and their potential economic implications is necessary to make informed decisions.


Inflation

Back in June 2022, we hit the highest inflation rate we have seen in over four decades. A year later, inflation is finally down to 3% year-over-year (YOY), a little under half of what we saw a year ago (Report posted by the Bureau of Labor Statistics on July 12th). The decline in Consumer Price Index (CPI) over the last 12 months is attributed to a decline in energy and commodity prices. The Bank Lending Survey (BLS) June report states: "The index for shelter was the largest contributor to the monthly all items increase," which accounts for over 70% of the increase. The battle isn't over, and the Federal Reserve continues to emphasize that they will have a few more interest rate increases by the end of the year. The US economy has remained resilient since the Federal Reserve began its contractionary policy in May last year. Currently, unemployment is 3.6%, a percentage point decrease from May. The June employment report posted by the Bureau of Labor Statistics shows an increase of 209k for total nonfarm payroll unemployment, slightly lower than previous readings and for the first time below its consensus in over six months; nonetheless, the labor market remains strong. Most recently, the National Association of Home Builders (NAHB) Housing Market Index hit the highest reading since July 2022, and homebuilder sentiment has slowly increased despite high mortgage rates, currently at 6.81% (Reading for the week ending July 6th). In June, the Bureau of Economic Analysis posted its Q1 2023 GDP estimate, which increased at an annual rate of 2%.


On the other hand, there was a 2.1-point decline in the US manufacturing Purchasing Managers' Index (PMI), now at 46.30 for May. Additionally, there was a decline in the services PMI and business confidence. Although inflation has been declining, we continue to have a tight labor market; we are seeing mixed readings, some indicators aren't signaling cause for concern, but others have already entered "recession alert" territory, which should not be disregarded as they indicate where the current economy stands.


Interest Rates

The Federal Reserve unanimously voted against another interest rate hike in June but clarified that they would resume in July. As rates continue to rise, long-term bonds will continue to be negatively affected, as well as stocks, yet they have become interest rate defiant as stocks rallied during June. Although we have seen considerable progress in bringing down inflation, it is still 1% over the Federal Reserve's target of 2%, reinforcing that they will continue raising interest rates. Even if inflation were to reach the 2% target level later this year, it does not indicate that the Federal Reserve will begin reducing the Federal Funds Rate. The next step for them is to maintain inflation at 2% without negatively affecting other economic factors; only then will the Federal Reserve gradually cut rates. At the same time, we need to consider the current business cycle and other economic indicators which determine the Federal Reserve's decisions for their upcoming meetings. I want to point out that even though the current economic environment does impact the market, investors are feeling bullish as news of disinflation and low unemployment reports are released.


Equities Rule

As we look back at the beginning of the year, there were many talks about a possible recession, the Federal Reserve cutting down rates, the Government defaulting on its debt, and in early March, we had a mini financial crisis where a few banks failed. Now we

we are halfway through the year, and we would have never imagined that seven stocks would rally the way they did around the current economic conditions. The FAANG (Facebook; now Meta Platforms, Amazon, Apple, Netflix, and Google; now Alphabet)still have ways to go before reaching their highest peak in November 2022. Still, they began an uptrend at the beginning of 2023. Most of this rally is attributed to the AI wave that has frenzied most investors as they see it as the new tech that will revolutionize the world.


Market Outlook

Financial analysts and professional investors only use historical data and mathematical statistics to "predict" market performance. However, as we have seen, every time is different, and it is nearly impossible to predict returns given the different economic environments. There are so many variables that could influence the performance of a stock; therefore, we would have infinite possibilities as to how the stock would perform given the changing variables. As your trusted advisor, we make investment decisions based on your current situation. Implementing different strategies helps us create portfolios to mitigate risks in any market environment. Currently, we are experiencing a market rotation. Consequently, we started shifting part of our value allocation into growth funds while maintaining a healthy balance without overly concentrating on a particular sector. As interest rates continue to rise, we will limit our exposure to bond funds and continue our decision to invest in individual short-duration treasury bonds and/or certificates of deposits.



As the economy adapts to the higher interest rate environment, we continue to remain optimistic but on the cautious side. Last year, many investors expected to see a recession by this time, but the overall economy remains resilient, and the market keeps showing signs of strength. In 2022, Equities were the biggest losers, followed by bonds, but this year equities are on a path to recovery, and bonds, on the other hand, have struggled to perform due to high-interest rates. Staying focused on your long-term goals is essential, as the market will experience difficulties. Unless a life-changing event triggers changes to your portfolio, please contact Corinthian Wealth Management to schedule a meeting.




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