Dear Clients & Friends,
It’s time for our monthly economic risk update. A quick preface for the
newcomers to our distribution list: both our monthly economic risk updates
and market risk updates are not intended for professional financiers, but for
our small family of clientele who appreciate real data presented in a manner
that they can absorb. So don’t fret, because it’s not terribly complex.
I also wanted to comment on the recent debt ceiling noise that seemed to
consume mainstream media. At no time were we concerned that the US
government would default on our debt. The fact is that, whether they would
admit or it not, the overwhelming majority of our congressional
representatives were well aware of the potentially catastrophic implications of
defaulting on our debt. In addition, mainstream news can’t control themselves
when they are given the opportunity to scare their audience, because doing so
is profitable, and that’s the world we live in. Fortunately, the market has gone
up 5% since the debt ceiling debate came and went.
Now for our risk update!
We continue to have a strong conviction that the US economy will not fall into
a deep recession with a hard landing, but rather gently slow with a soft, very
tolerable landing. While we will not attempt to forecast short-term general
market performance, we are highly confident that the market is likely to
experience a full recovery and reach its previous high of late 2021 by the end
of 2024 (hopefully earlier). We’ll discuss this further in the coming weeks. For
now, let’s get into our economic risk update.
Much of the data below has been compiled and presented by our good friend
Peter Esele, as well as by Dan Levinson from our Philly office. We follow four
indicators that have historically done a good job of warning us of an impending
economic slowdown. They are the Service Sector, Private Employment, the
Yield Curve, and Consumer Confidence.
ISM Services: PMI Composite Index
Because the service sector makes up roughly 75% of American economic
activity, it warrants close attention. The index dropped from 51.9 in April to
50.3 in May. While this marks five consecutive months of expansion, the trend
downward, in addition to recent volatility in the index, warrants a yellow flag.
Private Employment: Annual Change
The US economy beat expectations by adding 339,000 jobs over the month of
May, higher than the anticipated 195,000 jobs. This marks 29 straight months
of job growth, despite the plethora of headwinds during this time span. The
continued strength of the US labor market leaves this indicator at a solid green
flag.
Yield Curve: 10-Year Minus 3-Month Treasury Rates
The yield curve inversion grew larger in May, with the 3-Month treasury rate
rising from 5.1% in April to 5.52% in May. The 10-Year rate only rose from
3.44% to 3.64%. We are taking this data point with a grain of salt, as the
short end of the curve tends to rise more quickly in response to Fed action
than the longer end of the curve. However, it would be remiss to dismiss that
this marks 8 months in a row of an inverted yield curve, as the curve is one of
the most widely followed indicators of pending economic trouble. Caution
should be taken going forward. For this reason, the Yield Curve remains at a
red flag.
Consumer Confidence: Annual Change
Consumer Confidence dropped from 103.7 in April to 102.3 in May. While this
number remains in positive territory on an absolute level, this does mark 15
straight months of decline. While the absolute numbers remain outside of the
historical danger zone, the trend of continued decline does warrant some
attention, and we are giving this risk indicator a yellow flag.
In conclusion, May has brought a mixed bag of results. A strong labor force
continues to provide strength to the US economy and consumer, despite
dwindling confidence and economic headwinds. We expect slow and steady
economic growth going forward. However, the risks are real, and we should
remain cautious as we tread forward. Our aggregate economic risk factor
remains a yellow flag.
Keep in mind that part of the reason that the Fed raised rates was in order to
slow the economy and bring inflation down. Inflation is half of what it was one
year ago but remains high. While the Fed’s rate hikes have helped inflation a
great deal, they have not yet negatively impacted the labor market (which is
incredible). In fact, the United States is currently over-employed! (Yep, believe
it or not, our employment rate is higher than what is considered “full
employment.”) Therefore, we know that unemployment must rise in order for
inflation to fall further. So, when the media is screaming that the world is
coming apart because unemployment has risen by 1/10th of a percent, just
remember what Spock said in Star Trek: “the needs of the many outweigh the
needs of the few, or the one.” If unemployment has to rise by a fraction of a
percent in order to protect 99% of Americans from high inflation, that is
generally a good thing, not a bad thing (for most people.)
With that, we wish everyone a lovely weekend.
-Matt, Dan, and the rest of the MORWM home office