by Franklin J. Parker, CFA
The Summary
- A government shutdown is back on the radar. Current funding ends at the end of this month and without a spending agreement, many pieces of the government begin to shut down. While not nearly as dramatic as the debt ceiling showdown earlier this year, the government shutdown would likely dent economic activity and increase market volatility — on average, the S&P 500 falls about 0.4% in the weeks leading up to a government shutdown, and remain about flat until it ends.
- The economic data from last week was somewhat mixed. The services sector appears to be slightly stronger than otherwise thought, but still isn’t very strong. Pay for new hires has fallen quite dramatically in what may be an early indication that the labor market is weakening. This week we see all-important inflation data. Investors appear to be getting behind the idea that the Fed has successfully managed to create a soft landing. I remain skeptical — the historical record does not favor such a scenario, and the economic data has deteriorated. That said, if corporate earnings improve in this quarter and unemployment does not tick meaningfully higher, there is a case that history is being made.
The Details
I still see more risk than opportunity in this market.
Commercial real estate, to take one example, continues to show worse figures month after month. Occupancies are down, rents are down, prices are down, and many developers and investors are unable to refinance loans at rates comparable to a few years ago. Ultimately, banks are the ones left holding these failed properties, and we are seeing non-performing loans on the rise (though banks are very reluctant to foreclose). Not to mention, many of these banks have their own troubles with their bond portfolios — the dynamics that sunk Silicon Valley Bank and First Republic are still in play.
Evidence is also mounting that consumers, the lifeblood of the economy up to now, are beginning to hit some speedbumps. Labor market conditions have loosened, leaving employees with less leverage to negotiate higher wages. The considerable savings built through pandemic-era programs has mostly run out, and the student loan and rent payment moratoriums are coming to an end. Consumer behavior through the end of the year will likely determine how much life this economic cycle has.
There are counterpoints, of course. Consumers, despite almost everyone’s expectations, have kept spending. Jobs have remained plentiful (and still are), and the services sector is expanding (albeit slowly). Consumer and corporate Debts are still generally being paid and, as I have said before, the “recession is imminent” signals have not started blinking their warnings.
For markets to move higher, however, we really need a catalyst: strong earnings in Q3 could do it. 2015 – 2016 was a period when earnings contracted outside of a recession, only to recover and push markets higher for the next five years. Strong consumer spending would keep the economy afloat, and a recovery of the manufacturing sector would be a signal that things are landing okay.
At the moment, with current data, I see more downside risk than upside motion. Markets appear to be stuck in a sideways churn, with little to push them higher or lower. Given this economic data, however, I see downside risks looming large coming into the end of 2023. Investors should be cautious, though, as always, your individual objectives will govern which risks are more important to you.
Chart of the Week
Following on the article I wrote in Enterprising Investor, I have fielded several conversations surrounding cryptocurrency, and Bitcoin in particular. There is a great chart put out by LSEG group that shows the size of various bubbles in the past, from gold in the early 1980s to the Tech bubble of the 1990s. As this chart shows, all of them pale in comparison to the meteoric rise in Bitcoin price over the past decade. Will the massive rise in price hold? Or will the bubble pop? Really, only time will tell. There is no denying, however, that this has been among the most dramatic price movements in history.
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