Rhys Williams, CFA, Chief Strategist
September 1, 2023
With summer winding down, it’s a good time to look forward and discuss both economics and politics as we move toward 2024.
August was a difficult month for stocks and bonds. Heavy bond issuance, a lack of foreign treasury buyers and worries about longer-term inflation have coincided to send the 10-year and 30-year interest rates higher, decreasing the slope of the inverted yield curve in a not-so-positive way. This also hurt stock valuations. But still, the retreat was orderly for both asset classes. We think we are close to the end for bonds at above 4.5% on the 10-year, we will see increased pressure on all things real estate and automotive loans will come under greater origination pressure. Interest rates have not hurt home prices yet only because supply has collapsed. Sixteen years of extremely low rates means a large percentage of the housing stock is controlled by owners with mortgage rates less than half of current ones. So, housing prices haven’t reacted to a rising rate cycle as they have historically. The few homes for sale are gobbled up by cash buyers as there remain more buyers than sellers.
But make no mistake, rising interest rates always work, even if this cycle will be delayed. Small business loans will be difficult and expensive, so commercial and industrial (C&I) loan demand will continue to weaken, as banks have suggested. This could force the job market to cool, as businesses postpone expansion projects. Anecdotally, it was more difficult for college graduates to find a job in August 2023 than in August 2022, but this has not shown up in unemployment statistics yet.
We think the next several months’ inflation prints will be benign and we will be surprised if CPI doesn’t start with a “2” by the fall. Therefore, we believe the Federal Reserve will not have any ammunition to raise rates this fall, giving a modest boost to market sentiment.
Like Jay Powell, we are not convinced that inflation is permanently slayed. We agree that service inflation may prove less transitory than goods inflation. It is quite possible if we avoid a recession, that inflation could tick back up in 2024. But that is a 2024 story, and we believe that the inflation news will be good in 2023. We expect both stocks and bonds to rally modestly into year-end on this data, all things being equal.
Seasonally, the fourth quarter before an election year is historically strong.
Source: Oppenheimer & Co. as of 12/31/2019. Past performance is not indicative of future results.
The above graph from Oppenheimer & Co. shows the average performance, dating back to 1983, of the third year of a president’s term. As shown, while there is often a period of mediocre returns in the summer, it usually leads to a fourth-quarter rally. Obviously, there have been many different economic backdrops over the last 40 years, so it is interesting that returns are so favorable.
Unlike interest rates, we thought we would devote the rest of this commentary to two topics very much on the back burner in investors’ minds now. We believe that there is the potential for a government shutdown later in September or October, as the conservative Republicans demonstrate their toughness to their base, and since Trump is not President, they are freer to oppose fiscal largesse. Typically, government shutdowns are positive for the market; however, it will likely greatly impact the economy around Washington, DC as federal workers aren’t paid during a shutdown. But most of the US will chug along and not notice. Usually, a shutdown lasts for a few weeks before a deal is orchestrated. Neither party wants to be blamed for hurting the economy, and the leadership of both parties understands that the American electorate thinks spending is too high, but doesn’t want to cut any programs. This conundrum makes it very difficult for true austerity to emerge. There are not 51 Senate votes to cut almost anything, let alone a veto-proof 66. This, I believe, is why the Inflation Reduction Act will not be repealed even if Trump regains the White House. Government spending will remain stimulative for the foreseeable future, because that is what the American people want, even if they sometimes say differently. Eventually, interest on the government debt will force more fiscal prudence. But most politicians will be happy to kick the can down the road and hope the day of reckoning happens with someone else in charge.
The second political question of course concerns the Presidential election. It appears that the parties have selected their candidates well in advance of the New Hampshire primary. Barring illness, or a jail cell, it looks like Trump and Biden will have a rematch. Both candidates will have the difficult task of turning out their bases while also trying to appeal to the suburban voters in four swing states, which have the potential to decide the election. The Trump base is rural with a growing small business enthusiasm due to his personality and the good economy pre-Covid. The Biden base is urban, union workers and a variety of people who, for lack of a better term, don’t like Trump’s style. The differentiator this political season is the four jury trials that Trump may face. These judicial forays are likely to embolden both the Trump base, who already feel disenfranchised, and the Biden base, who will be reminded on CNN every night of the threat to Western civilization that Trump poses.
While it is necessary to turn out the base, it is also necessary to win the moderate suburbs in Atlanta, Philadelphia, Detroit and Phoenix. These were the counties that decided the last election as they swung massively to Biden compared to 2016. No doubt many of those voters were more anti-Trump than pro-Biden. But will it be enough in 2024 to run against Trump in those counties? We think both party platforms will try to thread the needle of appealing to their respective bases, but give something to these well-educated, wealthier, largely independent suburban counties, who are much less motivated by culture wars.
The good news is that we believe that both candidates can pivot to the center early in the contest, as the nominations are locked up before the first vote is cast. From the market’s point of view, this could be helpful, as the most extreme positions can be silenced. In general, these suburban counties are stacked with voters who have significant 401(k)s and care deeply about the economy. Once the base is secure, we think both candidates should try to articulate policies with which wealthier, suburban families can identify. Can Trump and Biden, who both have difficulty staying on message, keep focused on these elite communities? The truth is I don’t know. But, a short primary cycle and the electoral vote for virtually all states already baked in the cake, makes these few counties punch way above their relatively tiny voter weight. They are the swing votes in the very few swing states left in America. Just like the last election, the path to the White House leads through Bryn Mawr, Pennsylvania. Who would have imagined?
The views expressed are those of Spouting Rock Asset Management (“SRAM”) platform, as of September 1, 2023, and are not intended as investment advice or recommendation. For informational purposes only. Investments are subject to market risk, including the loss of principal. Past performance does not guarantee future results. There can be no assurance that any SRAM strategy or investment will achieve its objectives or avoid substantial losses. There can be no assurances that any of the trends described will continue or will not reverse. Past events and trends do not imply, predict, or guarantee, and are not necessarily indicative of future events or results. Investors cannot invest directly in an index.