Economic Outlook August 2023

First, let’s touch on the downgrade of the U.S. debt rating from AAA to AA+ by Fitch rating service. (The S&P rating service did the same thing 12 years ago.) We expect the rating change to have little impact how U.S. Treasury securities are used in world markets, and we expect Treasuries to remain the risk-free basis for pricing all other credit-based securities. Having said that, there is still a message in the actions taken by Fitch and S&P. The U.S. has elevated and growing debt levels, and elected officials have shown little ability or willingness to maintain fiscal responsibility. Furthermore, there are no visible plans to change that moving forward. One could argue that S&P’s rating downgrade came early, while Fitch’s recent downgrade validated the core thesis.

Longtime readers know we don’t put a lot of faith in near-term market forecasts. (Those who forecast don’t know, and those who know don’t forecast!) Last year at this time, nobody predicted the S&P 500 would be up 20% year-to-year, or the MSCI World up 19%, by the end of July. Both returns are in excess of long-term secular averages, suggesting something will happen at a future point as a counterbalance to bring returns in line with longer-term averages. For the stock market, that longer-term average is about 9%, and for the bond market it’s about 5%. With traditional valuation methods suggesting that markets are fully priced, maybe that comes sooner than anyone expects today. Then again, another saying comes to mind: “Markets can remain irrational longer than investors can remain solvent.”

Rather than try to predict what might happen in the economy or the markets for the rest of the year, our responsibility is to make the best decision today with funds that need to be invested. We look at asset classes, styles, sectors, subsectors and even individual issues (both domestic and foreign) to find the best values available that fit within long-term investment objectives. We are not ignoring economic conditions in this process. We see the data – the good, the bad and the average – that together, in all its forms, results in the economy we have today. The economy is so complex that singling out one or two data points as indicators for the future is where many forecasters fail in accurately predicting outcomes.

The Goldilocks outcome in the wake of the Federal Reserve rate hikes is to have an economic “soft landing,” where inflation declines and people remain employed while the economy avoids a recession. There is growing confidence in the prospects for this, but we remain on guard for the chance that it doesn’t happen. The lion’s share of economy reflects the consumer. While consumers remain employed – and typically spending almost everything they earn – there is growing unrest with wages lagging price increases. To make up the difference, consumers have tapped savings and decreased their savings rates. There also appears to be rising pressure on corporate earnings, indications of decreasing shipments of goods and more labor strikes.

In the wake of the fiscal stimulus and low interest rates after the pandemic, investors poured money into the stock market, using a “There Is No Alternative” (TINA) mantra for stock investing. Those excessive stock allocations were painful during the market decline we experienced last year. Now that interest rates have risen dramatically, we would like to make you aware of a “There Are Reasonable Alternatives” (TARA) approach to investing. With the stock market back near its highs, now might be a good time to review your overall investment strategy to make sure it is consistent with your risk tolerance and long term-goals.