June 2023 | Equity Commentary
Published on July 11th, 2023
Many economists have spent the past year anticipating a US recession. It did not arrive in the first half of 2023. The Commerce Department reported that real gross domestic product grew at a 2% annualized rate in the first quarter, which marked a significant upward revision from the previous 1.3% estimate. Exports and consumer spending were critical drivers of the additional growth, with the latter receiving continued support from a strong jobs market.1 Employers have added approximately 1.6 million new jobs so far in 2023, which is nearly double the pace set in 20192 – when the pre-pandemic economy was considered quite strong. In our opinion, economic outcomes in the year’s first half might aptly be described as “not as bad as expected,” which arguably contributed to the strong showing in equity markets. It appears that the regional banking crisis did not produce a broader financial contagion, the debt ceiling standoff ended without default, and higher interest rates have not pushed employment or growth materially lower. Stocks benefited at each turn, with the S&P 500 jumping +6.6% in June and rallying +16.9% over the first six months.3 The 10-year US Treasury bond sold off slightly in June to finish the month at 3.84% but remained mostly flat for the year.4
The Federal Open Markets Committee voted unanimously at their June meeting to hold the benchmark fed funds rate steady at 5% to 5.25%. Minutes from the meeting suggest that Fed officials largely believe additional rate increases may be needed to tighten policy further.5
Inflation has been trending lower but remains well above the Fed’s 2% target. Headline Personal Consumption Expenditure (PCE) inflation was up 4.9% year-over-year in the first quarter, though May’s print broke below the 4% level with a 3.8% annualized increase. Core prices, which exclude food and energy, registered at 4.6% in May, a slight improvement from April’s 4.7% level.6 We believe inflation should continue to trend lower in the second half of the year, but the distance between current readings and the Fed’s target suggests at least one or two more rate hikes are likely in 2023.
Contributing to the thesis of additional rate increases is the still-too-strong labor market, with the Labor Department reported employers increased payrolls by an average of 314,000 jobs per month through May. Payrolls do not tell the entire story, however, and other key metrics suggest the jobs market may be slightly weaker than headlines suggest.7 While June’s ADP report was an addition of nearly 500,000 jobs, more than double the estimate, the Bureau of Labor Statistics non-farm payrolls number for June was just 209,000, about 10% below consensus and a clear downtick from the average of prior months.8 Initial applications for unemployment benefits, a proxy for layoffs, are up approximately 20% this year, albeit from a very low level, and workers are quitting jobs at a much slower rate than last year – suggesting that prospects for better jobs with higher pay may be diminishing. The ‘quits rate’ (measures job separations triggered by the employee) has been trending lower since its peak at 3% in April 2022, but ticked back up to 2.6% in June, the same level where it finished 2022.7
The Institute for Supply Management’s June report on services and manufacturing activity was mixed, in our opinion. The US services sector remained in expansion mode for the sixth consecutive month, with Services PMI registering at 53.9. Among the strong contributors to services sector activity was the Business Activity Index, which rose 7.7% from May, and the New Orders Index, which increased by 2.6%. On the other hand, manufacturing activity remains weak. The June Manufacturing PMI was 46.0, a nearly 1% drop from May and the seventh straight month of contraction. Notably, the forward-looking new orders index remains firmly in contraction territory, at 45.6, while order backlogs fell and inventories shrank. All of these metrics point to slower demand. One positive to parse from the data was the price index, which fell to its lowest level in 2023. Easing price pressures factor as a positive for inflation and interest rates, and also signal improved supply chain conditions. 9
US consumers continue to support economic growth, with retail spending rising a modest 0.1% in May.6 When adjusted for inflation, spending was flat, which implies consumers are not tapped out but also not spending at robust levels. Monthly auto sales continue to trend upward as supply chain pressures have eased and helped availability of vehicles, while pent-up demand from recent years supports new car purchasing activity.10
The Conference Board’s measure of consumer confidence shows that Americans are largely upbeat about economic conditions, with the index rising to 109.7 in June from 102.5 in May.11 Strong jobs and wages helping, but we may see some pressure build in the fall when federal student-loan borrowers must resume making monthly debt repayments. We expect the market impact to be muted, however, given that student-loan payments are estimated to amount to about $6 billion to $9 billion a month – a small percentage of the $1.5 trillion that US consumers spend on goods and services every month.6
Overseas, China’s economy continues to show signs of weakening following an initial post-zero-Covid bump. The key manufacturing sector contracted for a third straight month in June, with a subindex on employment falling to 48.2 in June – a sign of continued stress in the labor market. Demand for Chinese goods is facing domestic and international headwinds, with China’s consumers losing steam and foreign buyers facing high inflation pressures. Political tensions are also weighing on economic prospects, as pressure is mounting on manufacturers and multinational corporations to diversify their supply chains and shift production out of China. Global equity markets would likely cheer a stimulus package from Chinese government officials to boost economic growth in the second half of the year, but it remains unclear whether Beijing will enact any meaningful new measures.12
Sources
1. Gross Domestic Product (Third Estimate), Corporate Profits (Revised Estimate), and GDP by Industry, First Quarter 2023 _ U.S. Bureau of Economic Analysis (BEA).pdf
2. Labor Market Headfake_ Key Report Could Be Overestimating Job Growth – WSJ.pdf
3. Bloomberg: SPX Index TRA Function
4. Bloomberg USGG10YR Index
5. Fed rate decision June 2023_ Fed pauses rate hikes, sees two more ahead this year.pdf
6. U.S. Inflation, Consumer Spending Growth Cooled in May – WSJ.pdf
7. Americans Have Quit Quitting Their Jobs – WSJ.pdf
8. Wage Gains, Low Unemployment Keep Pressure on Fed; Hiring Slowed in June, Jobs Report Shows – WSJ.pdf
9. https://www.ismworld.org June manufacturing and services reports
10. U.S. New-Vehicle Sales Rise an Estimated 13% in First Half of the Year – WSJ.pdf
11. US Consumer Confidence Improved Substantially in June.pdf
12. China’s Economy Shows New Signs of Weakness – WSJ.pdf
As of June 30, 2023
