What Recession?
The unambiguously strong increase in September payroll employment, reinforced by upward revisions to the two prior months, blew past market expectations and suggest that the recession is imminent thesis has totally disintegrated. Economic growth remains solid, which augers well for stocks, since profits may prove even stronger than currently expected.
The impending recession thesis was built on several points, but focused on a depleted consumer who would be unable to sustain spending. Job growth was slowing, job openings were declining, wage increases were moderating and the household savings rate had fallen sharply, all of which pointed to a slowdown in household outlays. Every part of that story just fell apart this week with incoming and revised data. With upward revisions to July and August, payroll gains hit 186,000 on average over the past three months, which is rather solid. Job openings increased unexpectedly, but that was on top of upward revisions to prior data. The unemployment rate declined for the second consecutive month to 4.1%. Gross Domestic Income in Q2 was revised up sharply and is now almost identical to GDP and both exceed 3%. Preliminary data suggests Q3 GDP growth of 3% or better. Wage increases had seemed to be moderating, but September reported the second consecutive increase on 0.4% for the month and a year over year gain of 4.0%. Moreover, recent wage agreements do not suggest any impending moderation in wage gains. And perhaps most importantly, the savings rate, which had been thought to be around 3%, was revised up and is now reported to be 5.2%. Thus, not a single part of the recession is imminent thesis held up.
Markets had been priced for ongoing sizable rate cuts by the Fed, roughly another 0.75% before yearend and several more 0.25 basis point decreases in 2025. Now it is unlikely that the Fed will be able to cut rates anywhere close to that amount. Perhaps more shockingly, it cannot be dismissed that rate hikes might be needed in 2025 if inflation increases. All of this is to be determined, of course. As always, the Fed and the markets are data dependent. But the case for economic weakness has taken a huge hit and there might well be second thoughts within the Fed whether they may have been too aggressive with the 50-basis point cut in September.
Stronger economic growth implies that the ongoing upward revisions to corporate profit forecasts were fully justified and could be revised even higher. Market valuations remain very wide ranging, with some favored companies trading at high multiples, while others languish. But the prevailing multiple for a share price is not sufficient to judge if that stock is too expensive or too cheap. The company’s growth prospects are another key element in judging the share price. The Mag 7 continue to trade at very high multiples, but they may be justified. The unloved S&P 493 trades a few multiple points lower, but deservedly so in many cases. These multiples must be placed in the context of the prospects for those companies to judge if the shares are cheap or expensive. But overall, we remain positive on equities and believe they have more room to run.
Such judgments are a bit easier for the bond market. While the yield curve has steepened considerably, long maturities still carry significant price risk if rates need to go back up. Similar yields are available from shorter intermediate bonds that carry far less risk if long-term rates rise further. We remain most comfortable in that short intermediate maturity range of 4 to 7 years, slightly below the duration of our benchmarks. We still expect the Fed to reduce overnight funding costs, but more slowly and to a lesser degree than anticipated by the market, which remains somewhat optimistic despite the repricing that occurred on Friday. So, we still see that short intermediate part of the bond market as offering the best combination of yield and risk.
Advisors Capital Management, LLC is an investment advisor registered with the United States Securities and Exchange Commission. Registration does not imply any degree of skill or training. All investing carries risk, including the potential for the loss of principal and past performance is no guarantee of future results. This content is for informational purposes only, can change at any time without notice, and is not investment advice or a recommendation to trade any security. Indices are not available for direct investment. We only provide services in jurisdictions where we are registered. Our disclosure brochure (ADV Part 2A) and customer relationship summary (ADV Part 3) are available at https://adviserinfo.sec.gov and upon request.
