Update on the Economy and Investment Markets 7-1-23

Welcome to the Stearns Financial Poolside Chat.

Happy Independence Day weekend! Many will be celebrating July 4^th early this weekend with traditional American flair – and perhaps, occasional flare-ups at the grill! This is a time to pause and reflect on the freedoms we enjoy in the United States, something none of us should take for granted as we review current events around the world. A few interesting facts that mark this holiday include: the Liberty Bell in Philadelphia which is tapped 13 times every July 4^th in honor of the original 13 colonies (the Bell explicitly states its purpose with an inscription that reads “Proclaim Liberty Throughout All the Land Unto All the Inhabitants Thereof”); John Adams, our nation’s second president, wanted July 2^nd to be the celebration day since that’s when the Continental Congress actually voted for independence (however, since the Declaration of Independence was officially adopted on July 4^th, this date became our now cherished holiday); coincidentally, both Adams and Jefferson died on July 4^th, 50 years after the historic document was adopted.

At SFG, we also celebrate this holiday in terms of Financial Independence, which requires thoughtful planning, hard work and on-going diligence – just like the American freedoms we enjoy.

It’s a tale of two economies, both domestically and internationally, as manufacturing and shipping industries struggle and are either near recession levels or contracting while service industries continue to do well. Evidence of the shift in consumer demand from goods to services is highlighted by the most recent Global Purchasing Managers’ Index of services business activity which remains well above 50, in growth mode.

The Federal Reserve has signaled it may raise interest rates by .25% – .50% in the next three to six months, though this decision will depend on how inflation is trending during this time period. While some predict not only a recession (see below) but an accompanying interest rate reduction later in 2023, we believe the odds of the Fed reversing course in the next six months is low. 

Our mid-year outlook for the balance of 2023 includes these key factors:

1. Rolling U.S. recessions will still happen, some severe, with the continued possibility of a modest overall recession,
2. Labor markets cooling off a bit as the U.S. economy continues to slow its overall growth,
3. Inflation continuing to cool (helped by softer labor markets and higher interest rates) with less volatile month-to-month swings,
4. Corporate earnings here and abroad doing okay, but not great,
5. Most real estate areas doing well, with plummeting office building values (an ultra-low weight for SFG currently) stabilizing,
6. Less political risk near-term with pressure, and drama, building towards the key 2024 elections,
7. Geo-political risks remaining elevated with many wildcards. The short-lived Wagner uprising in Russia created many risk factors that could feasibly be more troubling than Putin staying in power.

SFG’s Take: Today’s opportunities versus threats matrix still favors alternative investments, including real assets, private real estate (excluding office, although that sector is becoming more attractive) and global infrastructure, already incorporated in SFG portfolios.

Key Points to Consider

Inflation pressure

Egg prices may be plummeting, but post-pandemic inflation eruptions continue. One area that is going up dramatically is auto insurance. Loss trends have been high in the pandemic due to more accidents, bigger medical bills and increased litigation – industry experts believe rates will rise 5-10% per year for the next several years – this is in addition to the double digit increases already occurring. The National Association of Mutual Insurance Companies calls it the worst period for auto insurer losses in 30 years.

Frequently Asked Questions

Q:   In the last Chat you discussed how the largest eight stocks are driving U.S. stock returns in 2023, recovering their big declines in 2022. What about international stocks? They seem to be doing well in 2023.

A:   Yes, international stocks have been performing well compared to most U.S. stocks, just not quite as well as the Big Eight discussed in the last Chat. SFG has long favored “earnings power at attractive prices,” which is an attribute most overseas quality stocks enjoy today.

The paradox – we still view the U.S. economy as being very resilient and innovation as top notch, measured both by our leading research universities in the U.S. and patents and innovation coming from both public and private companies. Many U.S. stocks have attractive earnings power, but fall short on the second test – attractive prices.

Often, opportunities exist in areas experiencing difficulty. This concept holds true today in Europe. The eurozone economy shrank -0.1% in the first quarter of 2023, following a -0.1% decline in the fourth quarter of 2022 – the first back-to-back quarterly decline since the pandemic. This decline also counts as the mildest eurozone recession ever.

An “equal-weight” index represents the price of the average stock, with each stock getting the same market capitalization weighting. The equal-weighted MSCI EAFE Index of international stocks is up well over 20% (measured in U.S. dollars) from the end of October 2022 through mid-June 2023, meeting the technical definition of a new bull market. Yet the equal-weighted S&P 500 index (which dilutes the impact of the Big Eight) is up only 5% over the same period.

In general, the greater the number of stocks that are helping push the overall stock market higher, the healthier the advance. This broad support has been choppy in the U.S., but a bit better recently.

The average international stock continues to outpace the average U.S. stock, offering a broader base of support for the bull market to continue in international stocks.

Summary

Many factors still indicate a slower growth scenario for the U.S. and global economy. We see more rolling recessions already occurring in the U.S.  

Wildcard risks (low probability, high possible impact) discussed in this and previous Chats remain and suggest some caution. Included among these risks are Putin’s future actions. SFG is balancing numerous opportunities and threats in portfolios, customized to our clients’ unique circumstances.

Our “Sailing in Uncharted Waters” investing approach can be summed up by six themes:

• Diversification with a balance of offensive and defensive measures, depending on the desired risk tolerance of our clients,
• Underweighting, or avoiding areas of higher future concern,
• A focus on higher-quality investment themes,
• Identifying and implementing buying opportunities (includes alternatives to stocks) that may be appropriate for more growth-oriented portfolios,
• A more defensive stance using different portfolio tools for more conservative growth and income portfolios, and,
• Utilizing select alternatives to traditional bonds and stocks.

~ Dax, Dennis, Glenn, Jason, John and PJ
(The SFG Investment Committee)