Economic Update: November 20, 2023

Growth

The U.S. economy grew at an impressive 4.9% annualized rate in 3Q23, a sharp acceleration compared to last quarter. Many of the underlying details looked strong, as consumption, private inventories, single-family homebuilding and government spending all contributed to growth. On the other hand, weakness in private non-residential investment and a modestly widening trade deficit helped pare back gains. While the continued resilience of the U.S. economy is welcomed, this strength will be difficult to maintain. In the months ahead, a weaker consumer, tighter financial conditions and slower business spending should weigh on growth.

Jobs

The October Jobs report showed welcomed signs of easing in a tight post-pandemic labor market. Nonfarm payrolls rose by 150K, slightly below expectations, with backwards revisions of 101K tempering strong gains from the prior two months. The underlying details also looked soft. Payroll job gains were narrow in scope and most sectors saw hiring momentum slow, with the private sector only adding 99K jobs. In the household survey, an outsized drop in the number of employed people pushed the unemployment rate up to 3.9%, its highest reading since early 2022. Average hourly earnings rose by a modest 0.2% m/m, in-line with the pre-pandemic trend. Overall, with easing pressures from the labor market, inflation looks set to slide toward the Fed’s 2% target, even without further rate hikes.

Profits

The end of the 3Q23 earnings season is in sight. With 89.4% of market cap having reported, our current estimate for operating earnings per share (EPS) is $52.63. If realized, this would represent y/y earnings growth of 4.5% and a q/q decline of 3.8%. Revenue growth has been the largest contributor to earnings, adding 3.9%. Across sectors, energy has been the largest detractor while consumer discretionary has been the largest contributor. Management commentary has been relatively downbeat, painting a picture of a more challenged business environment ahead.

Inflation

The October CPI report was cooler than expected, providing further confirmation that disinflation is well underway. Headline CPI was unchanged on the month and up 3.2% y/y, while Core CPI rose by 0.2% m/m and 4.0% y/y. In the details, energy was a big detractor with gas prices down 5% while shelter continues to account for the majority of overall inflation. Core goods inflation was very soft with new and used car prices falling. Services ex-shelter and energy remains elevated due to outsized increases in car insurance, while medical services will recede as a driver of disinflation in the coming year. Overall, continued disinflation progress should keep the Fed on pause and keep yields off their highs.

Rates

The FOMC voted to leave the federal funds rate unchanged at a range of 5.25% to 5.50% for the second consecutive meeting, showing a willingness to be patient and proceed with caution. The Fed will continue to maintain its data-dependent stance from here, although Fed Chair Powell did acknowledge that risks are now more “two-sided.” That said, he made it clear that economic and labor market conditions will need to ease further to convince them that inflation is heading back to target. Moreover, the committee is not discussing rate cuts, keeping the “higher for longer” mantra intact.

Risks

  • Rates may stay higher for longer, presenting challenges to both stocks and bonds.
  • A slow-moving economy is highly vulnerable to any kind of shock.
  • Elevated valuations in some parts of the market may lead to volatility and market corrections.

Investment Themes

  • After 2022’s sell-off, fixed income now offers higher yield and more protection against a market correction or economic downturn.
  • Solid profit growth and reasonable valuations will be crucial in determining equity winners in a higher rate environment.
  • Long-term growth prospects, a falling dollar and wide valuation discounts support international equities.

This weekly update provides a snapshot of changes in the economy and markets and their implications for investors.

Originally Posted November 20, 2023 – Economic Update

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