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Several key factors have dominated the economic landscape throughout the year, including inflation, interest rate hikes, and the continuing struggle between Ukraine and Russia. Inflation has been a persistent concern, with rates remaining higher than the Federal Reserve's target of 2%. This inflation has led to increased prices for consumers and businesses alike. Additionally, the Federal Reserve has been grappling with whether to raise interest rates to combat inflation while balancing the potential impact on economic growth. Lastly, the ongoing conflicts between Ukraine-Russia and Israel-Hamas have raised geopolitical tensions, which can have ripple effects on the global economy. Despite these challenges, the market and consumers have shown resilience, adapting to the changing economic landscape and remaining cautiously optimistic about the future.
Inflation
Entering the last quarter of the year, the Consumer Price Index rose to 0.4% in September, part of the increase from the shelter and energy index. In the eyes of the Federal Reserve, this is relatively high compared to their 2% target, but if we go back one year, inflation was at 8.2% YoY, currently at 3.7% YoY. Core inflation, this excludes the most volatile items, food, and energy, has shown a slow but steady decline over the last twelve months.
Another economic indicator the Federal Reserve follows is unemployment. Non-farm payroll increased by 336k jobs during September, with an unchanged unemployment rate of 3.8%. Looking beyond the unemployment rate, the initial jobless claims have declined to levels last seen in February earlier this year. The job quit rate has dropped to 2.3% compared to the highest of 2.6%. A decline in job quits could signify slow wage growth, reducing consumer spending.
The Federal Reserve is determined to achieve a soft landing without risking a recession. At their last Federal Open Market Committee meeting, they announced another pause but clarified that another hike is likely during the November meeting. Furthermore, they released a summary of economic projections for the 2023-2026 years, and these projections show a reduction in GDP growth, increased unemployment, and slower deflation, where the 2% target is expected to be reached by
the end of 2025 or 2026. Consequently, we expect interest rates to remain elevated for the following year, well above 4%.
Interest Rates
Although rate hikes for 2024 are less probable, the number of estimated rate cuts has been reduced. The Federal Reserve’s summary of economic projections, released on 9/20/2023, shows that the federal funds rate is expected to have a central tendency range (excludes three highest and three lowest projections) between 4.4%-5.1% for the 2024 year. This range may seem insignificant to many investors, but the Federal Reserve is cautious about pivoting too quickly; bringing rates down could backfire and re-accelerate inflation. Over the last year, the economy seemed immune to the effects of a high-interest rate environment, but we are beginning to see some shifts as unemployment rises and GDP growth slows. The housing market continues to be affected as home sales have fallen due to rising mortgage rates. As of 10/12/2023, mortgage rates have reached 7.57%. The National Association of Homebuilders index (NAHB) has declined for three months straight, meaning homebuilder confidence is slipping. In addition to consumer demand weakening as home ownership becomes less affordable, home builders are also struggling with construction costs, which have increased over the last eight months. The real estate sector is not the only sector affected by high interest rates; utilities are also affected due to their debt levels, and the banking sector has struggled to recover since March’s mini-bank crisis. On a brighter note, longer-term treasury yields, 10-year and 30-year, have risen. We are seeing the yield curve become less inverted, which is what the Federal Reserve is trying to achieve. Usually, short-term yields going out 1-5 years are lower than long-term. Currently, long-term treasuries are yielding less than short-term. The rate increases have the intended effect of flattening the yield curve.
Geopolitical News
The conflict between Russia and Ukraine continues after over 580 days, which has led to a loss of life, massive displacement of people, and significant damage to infrastructure and cities. Both sides seem committed to continue fighting with no resolution in sight.
The most recent geopolitical incident is the Israel-Hamas war. The conflict escalated on October 7th of this year when Hamas fired rockets into Israel and carried out attacks, resulting in casualties among soldiers, civilians, and hostages. In response, the Israeli cabinet declared war against Hamas and initiated a complete siege of Gaza. The war has had devastating consequences for both sides and has attracted international attention and intervention efforts. The markets have remained neutral for now, but if the conflict were to escalate and turn into a larger-scale Middle Eastern war, it could have a much broader impact. The instability and uncertainty in the area could lead to increased inflation and, in turn, higher interest rates globally. It could also disrupt the oil markets through oil cuts or disruptions to oil transport.
The ongoing conflicts in Ukraine and Israel-Hamas significantly affect the global economy and geopolitics. These conflicts could disrupt global markets, particularly energy prices and supply chains. The conflicts also have broader implications for regional stability and international relations. Efforts to resolve these conflicts and achieve a lasting peace will be crucial. As a result, it is essential to monitor the situation closely and prepare for potential economic ramifications.
Markets
Aside from how the economy is affected by inflation and high-interest rates, people often ask how these economic factors influence the market. Overall, rate hikes negatively affect the equity market, but if we reflect on everything that has happened this year, the market has experienced rallies and downturns. In Q2 2023, we had the magnificent seven (Amazon, Apple, Google (Alphabet), Meta, Microsoft, Nvidia, and Tesla) deliver exceptional returns, contributing to most of the S&P’s return (Up 14% YTD, as of 10/11/2023).
In terms of sectors, telecommunications and Technology have been the leaders with the best performance YTD (date ending 9/29/2023), followed by consumer cyclical and energy. The worst-performing sectors are Utilities, Real Estate, and Consumer Staples. In short, equities will be affected, but we need to consider investor sentiment, the economy, and company earnings.
As for bonds, we are more optimistic as we approach the end of the Federal Reserve’s quantitative tightening policy and expect to see some cuts next year in 2024. Over the last two years, bonds did not serve their purpose as an inflation hedge, but with bond yields as high as 5%, we saw short-term bonds as one of the best investments with limited risk. Due to the constant adjustments in the interest rate, bond funds have not been delivering performance-wise; despite their increased yields, the risk may not be worth it for many investors.
Market Outlook
Given all the changes in monetary policy among the new global political issues happening worldwide, we will remain cautious as these events could negatively impact the market and the global economy for the remainder of 2023. Here at Corinthian Wealth Management, we understand that the market is constantly changing and adjusting to new information being presented. As a result, we use a combination of investment strategies to remain adaptable and flexible to any situation that could affect the markets.
Maintaining a well-diversified portfolio and focusing on the long term during a fluctuating market is crucial in protecting your assets. No matter what, volatility will always exist, and a downturn is not considered a loss until securities are sold. Staying focused on your long-term goals can help block out all the noise.
Finally, we continue to watch for new trends. Our portfolios are slightly tilted to Large Cap Growth and Large Cap Blend, maintaining a healthy exposure to all sectors and small caps to offer some diversification. We continue to favor short-duration bonds, but intermediate to longer-duration bonds may become more attractive as interest rates decline.
Sources:
https://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20230920.pdf
Nasdaq Dorsey Wright https://oxlive.dorseywright.com/reports/dali
Market Monitor week ending September 29, 2023. Goldman Sachs Asset Management. Advisor report.
The unemployment rate, nonfarm payroll, and job quits rate data were retrieved on 10/11/2023. Web. https://tradingeconomics.com
“Volatility Not a Financial Loss Until You Sell” Anatomy of a Recession presentation slide by Clearbridge Investments and Franklin Templeton. Fourth Quarter 2023.
https://www.cfr.org/global-conflict-tracker/conflict/israeli-palestinian-conflict