Notes on the Week Ahead

There is a slowdown lurking.  It is currently hiding so well, in the long grass of statistical anomaly, that many observers, including the Federal Reserve, don’t seem to notice it at all. However, investors need to recognize it and have a clear view on the outlook for economic growth, jobs, inflation and profits, how the Federal Reserve may react to a slowdown, and what this could mean for investment returns over the next few years.

In investing, as in life, it is important to learn from the past, appreciate the present and plan for the future.  This is particularly true at turning points. In the early weeks of the New Year, we do appear to be at an economic turning point.  Fourth-quarter GDP and consumption deflator data, due out this week, may give the impression of continued solid growth with still strong year-over-year inflation.  However, a more real-time assessment of the economy suggests a significant cooling in both, with monetary and fiscal tightening contributing to the slowdown.  That being said, it should be recognized that an environment of slow growth, low inflation, low interest rates and strong profit margins is likely to re-emerge in 2024, providing support for higher asset prices.  While there are too many short-term risks to justify a very aggressive strategy today, it still likely makes sense to prepare for this environment rather than trying to time market swings in what will likely be a very volatile 2023.

Last Friday afternoon, amidst the lengthening shadows of a winter sun, the Treasury Secretary delivered an ominous warning: By this Thursday, the U.S. federal debt will reach its legal limit, requiring her to take extraordinary measures just to keep paying the bills. Secretary Yellen’s warning was, perhaps, a little premature and she suggested that, with some adjustments, our real rendezvous with disaster might be postponed until June.  But even this date is considerably earlier than many assumed in the middle of last year, due, in large part to the budgetary effects of the Federal Reserve’s aggressive tightening.   

The word “resolution” has multiple meanings. The most obvious at this time of the year, is a decision to behave differently going forward. In many social sciences, “resolution” refers to a problem that is somehow mitigated or eliminated. Or, taken at its most literal, “resolution” could simply mean coming up with new answers to old questions – that is to say – “re-solving” them.

My first job out of graduate school, in the early 1990s, was as the consumer economist for the economic consulting firm of DRI/McGraw-Hill, in Lexington, Massachusetts.  One weekend each month, we would run a U.S. macroeconomic forecast.  (It always had to be over the weekend, as this was the only time when we could get our own clients off our mainframe computer.)  Anyway, on Saturday afternoon, having produced some preliminary numbers, we would gather around a huge conference-room table and discuss how the forecast was shaping up.    My colleagues were smart and seasoned economists and very patient with someone clearly just waking up to how forecasts are constructed in the real world.   However, I believe they did somewhat resent my position as “the consumer guy”.  Because then, as now, consumer spending accounted for roughly two-thirds of GDP and they would spend much of the weekend vainly trying to offset what they saw as my undue optimism by hacking away at their forecasts for investment, trade and government spending.

At his press conference on November 2nd, Fed Chairman, Jay Powell opined that the window for a soft landing had narrowed.  This was very much in line with his messaging for many months which has emphasized that the Fed regards inflation as being much too high and is willing to put the economy in recession, if necessary, to return it to its 2% target.  However, it also underscores the economic problem caused by “supply-shock” inflation: it simultaneously boosts inflation expectations, inducing a more restrictive monetary policy, and drags on economic growth.

At 8:30AM, on the first Friday of every month, the Labor Department releases the monthly jobs report.  By 8:35AM, the network scriptwriters deliver a verdict to the teleprompters – jobs either “sky rocketed” or “plunged”.  The job market is either “red hot” or “stalling out” and, either way, investors need to be worried.  No middle ground will keep an audience.

For many people, I suspect, 2022 will be a year to forget.  However, for millions of home-builders, home-sellers and home-buyers, it will be remembered for the speed with which a housing boom turned into a housing bust.  The reason, of course, has been a surge in mortgage rates.  These rates look likely to stay high, at least over the next year, contributing to sharp declines in housing starts and home sales and a negative impact on GDP.  Eventually, this could motivate the Federal Reserve to reverse course and cut rates.  However, mortgage rates are unlikely to fall to anything like the levels they maintained for the 14 years prior to 2022, while limited housing supply will probably prevent a collapse in prices.  Given this, it appears we are now entering an era when the decision to buy a house should be focused more on the finding the right home in which to live than the right asset in which to invest.

Markets bounced higher last week in a justifiable show of enthusiasm as the latest CPI data confirmed that inflation is indeed receding.  However, even as investors worry less about inflation they may well worry more about recession.  The risk of a near-term recession is climbing.  However, such a recession would be more like sliding into an economic swamp than falling off an economic cliff.  While a “swamp” recession wouldn’t be very deep, the economy would likely struggle to get out of it.  The good news for investors is that a prolonged period of economic swampiness should snuff out inflation and force the Federal Reserve to reverse a significant part of their 2022 tightening.

Among the many challenges of parenthood is trying to get your kids to eat healthy food.  As the children get older, the school lunchroom becomes one of battlefields, with some kind of weekly menu posted online or sent home with the kids.  Many of these menus appear to imply that the three essential food groups are sodium, fat and sugar.  However, some schools employ a little more imagination both in providing healthy choices and evoking some interest in the fare to come.  This week the lunchrooms in our own local schools will feature “Rocking Roll Ups” on Monday, “Healthy Half Days” on Wednesday and “National Sandwich Day” on Thursday, with vegetarian options available daily.  I’m not quite sure what all of that means but it does sound interesting.