Economic Outlook March 2023

Forecasters often begin with a conclusion, then search out data to support that conclusion while ignoring all data that suggests otherwise. We try our best to avoid this trap by looking into our magic eight ball and reading an assortment of tea leaves. (Just kidding!) We do try to start with data – always recognizing that it may not point toward one predetermined outcome. Instead, we evaluate the data’s significance and direction, blending those factors into the “elixir” that helps place probabilities around potential economic and market forecasts. The real trick is estimating the amount of time that passes while our primary thesis and forecasts take shape.

Make no mistake about it, today’s environment is very difficult to forecast. There is reasonable data to suggest continued economic growth, inflation moderating, and monetary policy execution working as planned. There is also reasonable evidence to suggest a slowing economy, inflation above the Fed’s target, and monetary policy disconnecting from economic conditions. Unfortunately, we don’t have the luxury of shrugging our shoulders and walking away from making a decision. After all, economic forecasting is one of the building blocks of our clients’ investment allocation and portfolio structure.

The narrative for a soft landing – where the economy slows according to the Fed’s plan but does not contract enough to create a recession – is fading. Our highest-probability outlook is for a “garden variety” recession that makes headlines but does not create significant problems. We see the window for this to develop in as long as 15 months, meaning we could continue through this year before seeing a mild recession sometime in the first half of 2024.

We are not seeing as much progress on inflation as we had initially anticipated by this point. The Fed says they are data-dependent, and so far the data is not going their way. This suggests that the fed fund rate may push higher than currently expected. With the interest rate spread between the 2-year and 10-year Treasury note already at negative 90 basis points, the higher fed fund rate could spill over into a higher 10-year Treasury rate. Rising interest rates reduce the market value of fixed income (bond) market values.

Stock market returns year to date are concentrated into the largest companies in the S&P 500: Apple, Microsoft, Amazon, Nvdia, Berkshire Hathaway, and Google. Combined, these companies have generated 60% of the return so far this year. If Tesla is added to the group, that brings the percentage up to 80%. This suggests there is not a lot of breadth to the stock market.

Interest rates have also been a challenge. Just two months ago, the market felt the Fed was at or very near the end of its rate hike cycle. Today there are forecasts for Fed rate hikes continuing through June. This rate perspective has spilled over into longer-term rates as well. The 10-year Treasury began the year around 3.9% and proceeded to decline to 3.4%, only to rise again to around 3.9% in early March. The last time the 2-year Treasury saw a 4.8% yield (where it was in early March) was nearly 16 years ago, in June 2007. It appears zero interest rates and quantitative easing strategies deployed by central banks around the globe for the last 14 years are ending – and giving way to more traditional structures that existed prior to the great recession of 2008-09.

If a person spent 15 minutes this year trying to estimate where the economy and markets are headed, about 14 minutes would be wasted. These conditions are a great reminder of why it’s so important to look beyond fads and focus on meeting long-term goals.