Economic Resiliency

For those of you who would prefer to listen:

2023 was supposed to be the most telegraphed economic recession in memory. To be sure, things have definitely been slowing. That’s been evident throughout retail and manufacturing. People are buying less stuff. Commodity prices, from Oil to Steel to Copper, fell to multi-month lows. It’s a sign of shrinking demand. Those segments of the Economy have been weak. It’s also deflationary. But not everything has been weak. Travel and entertainment are as strong as ever. It’s been hard for companies in those industries to find workers. TSA just recorded airport traffic over the Memorial Day weekend that eclipsed the 2019 record, pre-Covid. The American people are out and about, and they’re definitely consuming. The recession keeps getting pushed out. The Market likes that.

Anyone who wants a job can find one. That’s been the case for a while now, as the unemployment rate fell to levels not seen since 1969. The theme continued in May. 339K jobs were created last month. It blew away expectations. The Street was looking for 190K. On top of that, April’s report was revised higher to 294K (it was 253K). Even March got a bump up to 217K from 165K. The Labor Market has been the strongest segment in our Economy. People who want a job pretty much have one. People who have a job tend to spend money. Consumer spending accounts for 70% of economic activity in America. With so many jobs needing to be filled, wages have increased. Wage inflation is the one area that remains elevated and sticky. It’s been a conundrum for the Fed.

The thinking headed into the week was that the Fed was going to pause its aggressive rate hike campaign at the June meeting. After spiking the overnight rate from near zero to over 5% in just over a year, there have been increasing calls for the Fed to stand back and assess its progress. The Market has been pricing that in. Going into the weekend, the Market assigned a 70% probability of no hike on June 14th. It was 80% on Thursday. It was a mere 35% a week ago. Volatility is everywhere. It doesn’t usually show up this fast in gaming the Fed.

Remember, the Fed still has a goal of 2% inflation. We’re a long way from that. It clocked in at 4.9% in April. It was 9% a year ago. You can clearly see it’s heading in the right direction. But it will likely take much longer to get from 5% to 2% than it did from 9% to 5%. Inflation can be stubborn and sticky. Especially when the Job Market is so hot. Fed Chair Powell has repeatedly pointed out that labor remains unsustainably tight, and supply and demand need to get into better balance for inflation to retreat toward the Fed’s 2% goal. It sounds like more hikes can’t be ruled out this year. The Job situation is making that case. It certainly doesn’t seem likely that we see cuts in 2023, something that had been priced in earlier.

The debt deal; It didn’t come to the final hour, but it sure was close. Congress finally cut a bipartisan deal to eliminate a debt default. The House passed the bill on Wednesday in a decisive 314-117 vote. The Senate passed it Thursday by a vote of 63-36. It now goes to the White House for the President to sign it into law. Our government agreed to suspend the debt limit until January of 2025. In exchange, they put a cap on some non-defense discretionary spending as well as making work requirements stricter for some recipients of food assistance. This from the President: “No one gets everything they want in a negotiation but make no mistake: this bipartisan agreement is a big win for our Economy and the American people.” A compromise was made. As we know too well, compromise has become a bad word in Washington.

The debt deal was definitely a sigh of relief. It triggered another rally on Wall Street. Friday was the first Dow day we’ve seen in what seemed like, forever. There was a 700-point surge. The last couple of months have been driven by a handful of stocks, predominantly Tech. AI has been the meteoric theme. Of course, you already know that. The broadening out in participation is a really good thing in our minds. Stocks that have been left for dead, are coming back to life. Friday saw Industrials, Materials and Energy soar while Tech, quite frankly, took a breather. The Dow is heavily weighted towards those cyclical sectors. It was decisively a Dow day. Even small caps joined the party. Small companies have struggled mightily in 2023. They are generally much more impacted by rising interest rates because they often need to borrow to fund their businesses. And the Small Cap index is heavily weighted in regional banks, a sector that got clobbered in response to Silicon Valley and the banking crisis.

Something else that triggered the cyclical trade was news overnight out of China that its government was going to provide additional support to its Economy. 2023 was supposed to be the year of China’s re-opening. It had been closed for 3 hard years of Zero-Covid policy. An economic revival was expected. China’s Stock Market experienced a boom to start the year. It didn’t last. A 20% decline followed. The recovery didn’t materialize as expected. China continues to evolve from an export-led economy to that more tied to consumption. Also playing a role in investor concerns is politics, both inside and outside the country. Geopolitics are always a risk. The relationship between China and the United States has certainly soured. But the economies are firmly intertwined. We are part partners and part adversaries. The term “Frenemies” seems to fit.

China’s focus on national security makes its government’s policies less growth-friendly. The tight grip of President Xi handcuffs business leaders and stymies innovation. It has many obviously worried about Taiwan. The Communist Party set an economic growth goal of “around 5%” for 2023. China’s Economy grew 4.5% in the first quarter. That’s the fastest growth in a year. But it’s well south of its pre-Covid growth of 6% and the roaring 14% growth from a decade and a half ago. Representing the second largest economy in the world, with a population 1.5 Billion, a recovery in China would naturally trigger increased commodity consumption and a kick-start to the more cyclical areas of the Market. That’s what Friday felt like.

It has definitely not paid to be diversified in 2023. The thing is: Diversification is Investing 101. It appears a change might be in play though. Participation expanded under the surface this week. It’s a theme we will be tracking quite closely. One thing that’s certain: The American Economy sure is resilient.

Have a nice weekend. We’ll be back, dark and early on Monday.


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