What’s New

What do inflation, the economy, and markets have in common? The Federal Reserve’s rate hike campaign and it’s potential to push the US economy into a recession. The notable news in June was that policymakers opted to postpone another hike, for the first time in this tightening cycle.

They favored a month of holding interest rates to gather another round of economic data to assess the impact of the campaign so far. With pauses not being the norm, what should we expect going forward? Based on the dialogue at the June meeting, we should anticipate two more rate hikes this year, with the next being in July at the next meeting at the end of the month.

As for the economy, it’s strength continues to prove resilient – and has surprising momentum. Data from the first half of the year reports stronger growth than expected, especially seeing as many predicted a recession by now. Even areas that are sensitive to high interest rates, like housing, saw growth. The labor market also remains healthy although there have been numerous headlines regarding layoffs, weekly jobless claims fell to a multiweek low at the end of June.

Markets are on the upswing after clinching significant gains, locking in a strong six months for the start of the year. Optimism from investors that inflation is easing, and the economy is hanging on showed throughout June. Following the Fed’s decision to pause rate hikes, the S&P 500 secured a higher finish for a fifth straight week. This is a breath of fresh air after a difficult 2022 and first quarter of 2023 with the onset of the banking crisis.

Tech was the champion behind the recent rally as a group of eight companies drove performance, fueled by the growth of artificial intelligence (AI), tech companies are ushering a new computing era. This innovation has not been limited to just computers and handheld devices, but it has also moved into the automobile space for self-driving cars. Notably, the Nasdaq Composite, the tech-centric index, had its best first half of a year in four decades.

Cyclical stocks, which are known for their alignment – booming and busting – with the economy, had a strong month. Overall, all 11 sectors of the S&P 500 saw gains in June. As for treasuries, yields increased in the second quarter following strong economic strength, with potential to push higher in the coming months.

Our Perspective

As this cycle unfolds and we move further through 2023, our base case remains to be that a recession will be difficult to avoid with the degree of tightening that’s occurred and the work that remains to be done on the inflation front.

Knowing that a recession is our base case, it is important to approach this uncertainty with the right perspective. As the landscape ebbs and flows, we are analyzing all components of monetary policy, economic data, and the evolution of the market to prepare our shopping lists to put our time-tested processes to work.

Our analysts are working on identifying the companies that can generate strong cash flows through this economic cycle and have competitive positions within their industries, with an emphasis on high quality and economically resilient companies as seen through the lens of the profile strategy. For the pro-cyclical areas, we’re continuing to build our shopping lists while waiting for a better opportunity to increase our exposure to those areas of the market. We believe that this is the time to be selective with an emphasis on risk management.

Pulse Check: The Consumer

While we are starting to see cracks in the forward-looking economic data, areas of the consumer still look healthy. The latest consumer spending report supports the resilient consumer, and that they’re still willing to spend. We cover the report and share our take on the health of the consumer.

Read more: Pulse Check: The Consumer

Our View

• Economic Cycle
• The economy is late cycle; the Fed is being forced by high and persistent inflation to tighten into an already weakening economy; a recession in the US is becoming increasingly likely
• Stock Market
• US stock market weakness has improved valuations, however, equities are not cheap by longer-term historical standards; valuations may be partly explained by robust corporate profitability, as EBIT margins climbed to historical highs in the years following covid lockdowns; elevated input costs and weakening demand are posing a risk to the ability of corporations to maintain this elevated level of profitability; returns will be harder to come by and stock selection will be increasingly important
• Bond Market
• Interest rates have risen well off their lows reflecting shifting expectations on inflation, growth, and central bank policy; corporate and municipal bond credit spreads have widened, but not enough to make them materially more attractive at this time
• Important Issues on the Radar
• Inflation: a confluence of massive policy stimulus, tight labor markets, gummed-up supply chains, and rising energy costs have caused inflationary forces to broaden and become more entrenched than previously expected
• Ukraine-Russia War: an environment of elevated geopolitical risk entails a general risk-off environment, lending upward support to the dollar, gold, and commodity prices
• China’s Economy: China has pivoted on the two key economic issues that acted as severe headwinds to growth over the last two years; however, economic growth appears to be weakening as the recovery loses steam

Source: Wall Street Journal.

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