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 December CPI report came in slightly stronger than expected, with headline CPI gaining 0.3% m/m and 3.4% y/y. Shelter remained the largest contributor to inflation, rising 0.5% m/m, although real-time data on rents continue to suggest a slowdown ahead. Elsewhere, core inflation maintained its 0.3% m/m pace but eased slightly on a year-over-year basis. In the details, core services excluding shelter remained elevated, supported by airline fares, medical care services and a 20.3% y/y jump in auto insurance prices. That said, auto insurance prices should trend lower once rates roll over. Overall, this stronger report challenges the market’s expectation for policy easing as soon as March. Despite this, we still believe inflation can reach 2% by the end of the year, although the path down may be uneven.
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 16, 2024 – Economic Update
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