Markets in Brief
The economy continues to move forward with resilience despite the fed's efforts to slow the train.
The US economy expanded at a remarkably strong pace in the third quarter even as interest rates hit their highest level in 22 years. The Commerce Department reported that gross domestic product, a measure of all goods and services produced in the economy, grew at an annualized 4.9% rate in the third quarter.(1) This explains all the cars on those busy roads.
This is a testament to resilient growth even as mortgage rates spill over 8%.(1)
This economic acceleration was a surprise to many. In recent weeks, Jamie Dimon of JP Morgan Chase (who has forecasted a recession for the last eighteen months) noted he was shocked that economists, along with him, have been consistently wrong about a forthcoming recession.(6) No surprise...this is nothing new in history. Financial executives and economists have always been unreliable economic forecasters. Many of the world's largest brokerage firms illustrated this when they made heavy financial commitments prior to the Great Recession that either pushed them over the edge and shut them down (Lehman Brothers) or caused them to be taken over to avoid shutting down (Merrill Lynch). At the time, this was a fundamental misreading of the extraordinary speculation occurring in real estate and mortgage securities.
In the meantime, the Fed is doing it's best to nudge down inflation while avoiding an outright recession. With baby boomers retiring en masse every day, the labor market remains tight - the Bureau of Labor Statistics reports that unemployment remains very low at 3.5%. Healthy employment tamps down the risk of economic slowdown.
What About Interest Rates?
As noted above, nationwide mortgage interest rates breached a 22 year high point. According to bankrate.com, 30 year mortgage rates have risen to the 8% level.(1) Interest on a $375,000 mortgage borrowing (90% of the average U.S. home price) two years ago at the average rate of 2.90%(1) had a first year cost of $10,875, but this has now increased to $30,000.
It is no surprise that housing affordability is at an all time record low.(1) Very few can afford to buy homes with nosebleed prices that are now coupled with multi-decade high interest rates. According to researchers, median home prices last year in 99% of 575 U.S. counties were found to be beyond the reach of the average income earner, who makes $71,214 a year.(7)
Markets are Sorting Things Out
There is now a battle going on within investment markets. This caused an October decline in 14 out of 15 asset classes we track...there was no magical solution to asset allocation in October.
This is where the battle is playing out: market participants are positioning themselves to profitably allocate for the conflicting prospects of continued economic growth vs recession, and the timing and degree of interest rate direction.
Recession: Investors no doubt despise recessions. It is one of the few times it makes sense to lighten up exposure to equities. The hard part is forecasting one...markets sense and often know recession before it arrives. The latest data suggests that this is not a big current risk.
Economic Growth: Excessive growth fosters higher interest rates, while moderate growth fosters higher profits and full employment. Many investors are optimistic that moderate growth can be achieved and remain committed to growth-oriented securities, which is a contrary perspective to the recession camp.
Interest Rates: Interest rates levy a cost on all asset categories in the universe. This includes securities markets, real estate and all other asset categories. Markets are not fond of higher interest rates because they weigh on values, increase the cost of doing business and tamp down profits.
With economic growth rate of 4.9% in the third quarter, recession is not an immediate risk. But market participants now know that interest rates can stay up higher and longer than they anticipated. The prospect of higher interest rates longer is now something to consider in pricing all asset classes, and hence our perspective suggests this caused some pullback in October.
The Crystal Ball
We suspect that inflation fears will dissipate. Recent statistics show that core inflation is trending down. The Fed's 2-3% inflation goal is getting closer, it's just a matter of time. Inflation measures came in at a 4% rate most recently, a big decline from 2022's peak of 9.1%.(5)
It will be important to be positioned well when there is the smallest whiff of lower inflation in coming months. Markets will respond vigorously to this good news.