October 2023 Stonemark Market Commentary

October unfolded as a profoundly challenging month, casting a shadow not only over global markets but also over humanity as the conflict in Israel took center stage with its far-reaching impact. The consequences of this violence undoubtedly represent a tragic ordeal for all individuals impacted, and they remain in our thoughts and prayers during this difficult time. Subsequently, an initial surge in oil prices following these attacks underscores the potential for exogenous events to affect the global economy. In October, investors had to face several challenges. These included assessing the implications of the ongoing UAW (United Auto Workers) strike, the resumption of student loan payments, a narrowly-averted government shutdown, the first-ever ousting of a Speaker of the House in U.S. history, a surge in long-term interest rates to their highest levels since 2007, and a significant selloff in the stock market that eroded a considerable portion of this year's gains. The recent Israeli-Palestinian conflict has made predicting the economy's direction even more difficult. Considering these circumstances, now is an opportune time to reevaluate the economy's status regarding growth, employment, profitability, inflation, interest rates, and the associated risks and opportunities.

The Bureau of Labor Statistics released the Consumer Price Index (CPI) report on October 12 for September. According to the report, headline inflation remained stable at 3.7% year-over-year, the same as the previous month. However, the month-over-month number slowed down to 0.4% in September, from 0.6% in August but was still higher than the expected 0.3%. More than half of the increase was due to the contribution of shelter. Meanwhile, core CPI, which excludes food and energy, continued to decline, reaching 4.1% year-over-year compared to the previous month's figure of 4.3%, which was as expected.

As of the start of October, wholesale gasoline prices decreased due to declining crude oil prices. However, the attack on Israel could change this trend if the conflict escalates. If the situation remains controlled, energy prices will reduce inflationary pressures in the upcoming months. This could result in a 2% CPI increase by 2025, aligning with the Fed's target.

In September, the U.S. job market saw a rise in hiring pace, adding 336,000 new jobs. Despite the use of the term "recession" throughout the year, the employment growth indicates that the economy is relatively resilient, even with high-interest rates, labor disputes, and dysfunction in Washington D.C. The increase in non-farm payrolls during September was better than expected. However, stronger job growth can be attributed to excessive demand in the labor market rather than to economic growth alone. Despite this, the stock market declined due to concerns that the labor market's strength could lead to the Fed raising interest rates.

The unemployment rate remained stable at 3.9% in September after rising in August to its highest level since February 2022. The labor force participation rate and the employment-population ratio also remained unchanged at 62.8% and 60.4%, respectively. The information sector experienced a decline of 5,000 jobs in September, with the motion picture and sound recording industries being hit the hardest. They lost 7,000 jobs in September and have seen a decline of 45,000 jobs since May due to work stoppages that have disrupted Hollywood production schedules. After the September meeting, Fed Chair Jerome Powell commented that progress towards limiting inflation could be achieved through significant rebalancing in the labor market without increasing unemployment. However, he also mentioned that to meet their inflation targets, it would be necessary to experience a period of below-average growth and some softening of labor market conditions, which have yet to materialize this year.

Recent data indicate that the economy continues to grow at a very strong pace in the third quarter, with real GDP (Gross Domestic Product) growth exceeding 4.9% on an annualized basis. Real consumer spending, which makes up more than two-thirds of GDP, has grown by 4% annually. This growth is expected to be supplemented by strong net exports and government spending gains. Investment spending, on the other hand, remains remarkably resilient despite higher interest rates. This is encouraging news, as the GDP increase marked the biggest gain since the fourth quarter of 2021.

However, it is important to note that consumers will face greater pressures in the fourth quarter and in 2024. The resumption of student loan payments will drag on spending for younger households. Additionally, higher mortgage rates and auto-loan rates will likely suppress home and vehicle sales. If extended and expanded, the UAW strike could represent a major hit to output. Fiscal policy will also likely grow tighter due to any eventual deal on the fiscal 2024 budget. Furthermore, the recent increase in long-term interest rates, combined with the earlier effects of Fed tightening on short-term interest rates, will continue to compress bank lending standards and impact business activity. This may result in many less profitable firms being forced to cut back.

The Conference Board recently released its Leading Economic Indicators (LEI) report, which combines 10 forward-looking economic indicators. The report showed slight improvement, with the combined index (LEI) declining by 0.7 percent in September to 104.6, following a decline of 0.5 percent the previous month. The Conference Board stated that the LEI for the U.S. has fallen again in September, marking a year and a half of consecutive monthly declines since April 2022. Although the six-month growth rate in the LEI is somewhat negative and the recession signal did not sound, it still signals the risk of economic weakness ahead. Despite rising interest rates and high inflation, the U.S. economy has shown considerable resilience so far. However, The Conference Board predicts that this trend will only last for a little while longer, and a shallow recession is likely in the first half of 2024. In other words, The Conference Board now expects only a shallow recession, while the Fed expects a slowdown but no recession. Both organizations have improved their estimations from the beginning of the year.

As per the data from October, the economy is showing signs of gaining momentum without an increase in inflation, which was a concern for many, including the members of the Federal Reserve. However, there are still uncertainties, such as domestic politics, geopolitical issues, industrial action, and the possibility of policy errors. Hence, it is recommended to approach long-term investments in equities, fixed income, and alternatives cautiously while closely monitoring valuations and diversification in a complicated financial environment.