What’s Important?
Co-authored by David Lieberman, M.B.A., Partner / Portfolio Manager Director of Investment Research
Economic growth continues to roll along, while the moderation trend in inflation is slowing and possibly even stopping. So, the belief that multiple rate cuts by the Fed are still coming in 2024 is falling apart. The increased likelihood that rates will stay higher for longer is an obvious headwind for equities and even more so for bonds. Rising profits in a solid economy serves as a significant offset. Expectations for profits are being revised higher for the year. These conflicting forces are likely to add some volatility to stock prices over the course of the year, but such fluctuations are quite normal. Politics add another element of uncertainty, especially in an election year. But the election outcome is more likely to matter more at the company or industry level than at the macro level.
Growth remains rather healthy, and there are no signs of recession, nor reasons to think one is coming. Inflation prospects are the key. But without clear evidence that inflation is moving towards the Fed’s 2% target, there is simply no justification for the Fed to move policy into a more accommodative stance. The most recent inflation reports open the door to a rising possibility that further progress to 2% may require more policy action. It is premature to expect such a change. But at this point, our base case is that no rate cuts are coming this year.
Solid economic growth is the fundamental factor that has slowed the trend in moderating inflation. Demand has remained robust and businesses are hiring to keep up. The low level of unemployment certainly would have increased wage inflation pressures without a sizable influx of legal and illegal immigrants to fill all those jobs. Even so, we have seen increased strike activity, sizable increases in union negotiated wage packages, legally mandated minimum wage hikes, and company-initiated wage increases to keep up with the pay packages of competitors. At the very least, it seems appropriate to conclude that the tight labor market will prevent much further moderation in labor costs. Maybe AI will help on a secular basis, although that certainly will take plenty of time. Cyclically, the tight labor market appears to be placing a floor under labor costs and inflation more generally.
Despite the current strength in the economy the backdrop supporting growth is slowly moderating. Higher rates appear to be working down the excess strength in the economy. The number of job openings continues to fall, but remains higher than prior to the Covid induced recession. If the rate of the slowing continues then it may take until the end of 2024 or early 2025 for the number of job openings to return to a more modest level which could then push the unemployment rate higher. This also suggests the Fed may need to wait before cutting rates.
Politics could influence this closely balanced growth of labor demand to labor supply. For example, if any changes were to occur with regard to border policy that slowed illegal immigration, the labor market would become very tight, and wage pressures would quickly appear. Economic growth would also slow, since firms would be less able to hire the workers they need, and the growth in household income and spending would slow along with the hiring. Such a change in policy is possible as Republicans try to trade border policy for increased foreign aid to Ukraine and Israel. Policy could also change as a consequence of the upcoming election.
At the industry level, the energy sector will clearly be highly sensitive to the election. If Biden is re-elected, policy initiatives to promote renewables will likely remain central, and investment in oil and natural gas will continue to face hurdles. Subsidies for renewables are likely to be curtailed and opposition to investment in oil and gas will decline if Republicans win the White House.
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