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, weaker equipment spending 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 December Jobs report showed stronger than expected job gains to end 2023, but the underlying details suggested more weakness than meets the eye. Nonfarm payrolls rose by 216K, handily beating expectations, although downward revisions removed 71K in gains from the prior two months. In the household survey, the unemployment rate remained at 3.7%. However, a 676K decline in the labor force and 683K decline in the number of employed persons pointed to a lack of momentum. Wage growth came in above expectations, rising by 0.4% m/m and 4.1% y/y. While strong at the headline level, this report showed slower than expected labor market momentum and stalling progress on wage growth, challenging the “goldilocks” narrative of both strong economic growth and lower inflation.
Profits
The 3Q23 earnings season is now behind us. Our final estimate for operating earnings per share (EPS) is $52.23, which represents y/y earnings growth of 3.7% and a q/q decline of 4.8%. Revenue growth has been the largest contributor to earnings, adding 4.0%, while contracting margins pared back gains. Across sectors, energy has been the largest detractor, while consumer discretionary has been the largest contributor. Management commentary was relatively downbeat, painting a picture of a more challenged business environment ahead.
Inflation
The November CPI report provided further evidence that inflation is trending back to target. Headline CPI rose 0.1% m/m and 3.1% y/y in November, slightly above consensus but down from October, while core CPI rose 0.3% m/m and 4.0% y/y. In the details, a sharp decline in energy prices helped alleviate pressure in the headline figure. Core inflation was supported by gains in auto insurance and shelter prices, but forward-looking rent and auto prices suggest a trend lower ahead. Elsewhere, the PCE price index showed further progress on inflation. Headline PCE fell by 0.1% m/m and rose 2.6% y/y, while the core measure gained 0.1% m/m and 3.2% y/y. While the CPI report was slightly stronger than expected, recent data confirms that inflation is moving in the right direction and may reach the Fed’s target by mid-2024.
Rates
At its last meeting of the year, the FOMC kept rates at 5.25%-5.50% and strongly hinted that rates are at their cycle peak. The median FOMC member now expects three rate cuts next year to 4.6%, an extra cut compared to the September dot plot. Moreover, updates to the Summary of Economic Projections showed lower inflation forecasts for 2023, 2024 and 2025 without material revisions to the growth or employment forecasts, suggesting that the Fed is forecasting a soft landing. In the press conference, Fed Chairman Powell did not push back against easing financial conditions or the idea of rate cuts, as he has done in the past, and forward guidance was decisively dovish. Looking ahead, the next policy move will likely be a cut next year.
Risks
- Rate cuts may not occur as quickly as expected, 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
- Despite the recent bond market rally, fixed income still offers attractive yields and protection against an 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.
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Originally Posted January 8, 2024 – Economic Update
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