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Mixed Signals

Third Quarter 2023

“Economics is extremely useful as a form of employment for economists” – John Kenneth Galbraith, Economist 


During the first half of 2023, equity markets rose across the globe as anticipated declines in consumer spending and economic growth failed to materialize. In the U.S., the stock market rally hinged on the strength of a handful of technology companies, the new promise of artificial intelligence (AI), and encouraging corporate earnings – overall, down only slightly from a year ago.

At the same time, bond yields stabilized as the Federal Reserve paused 15 months of interest rate hikes in May. This stability was largely due to lower inflation; after peaking at more than 9% last summer, U.S. inflation ended the quarter at 3%. (Note that this does not mean overall prices are falling, only that they are rising less quickly than twelve months earlier.)

At the start of 2023, economists seemed to agree that a recession was approaching in the second half of the year. The massive boost in industrial production and capital spending brought on by the COVID stimulus faded by 2023, as these metrics suddenly showed exceptionally low readings after over a year of exceptionally high readings. These gyrations lower immediately led to many articles of gloom and doom.

However, what appeared to be the most telegraphed recession in history has yet to occur, as unemployment remains low, wage gains remain strong, and consumer spending is at higher levels than a year ago.

This quarter we felt a graphical display of the contrasting data points would be of interest to our readers, providing a more detailed look into the various cross currents present in the economy.

– Mitchell Sinkler & Starr’s Portfolio Managers


With energy prices leading the way down (average U.S. gas prices were 22% lower this Memorial Day than they were a year ago), month-over-month inflation readings continued to come in well below those from the first half of 2022. In response, Fed Funds rate increases were paused in June, as the Federal Reserve elected to wait for more clarity on inflation and the economy in general.

On its current path, year-over-year headline inflation could end 2023 closer to 3%. While this might be a boon for corporate earnings due to lower input and transport costs, it may also signal that consumer spending growth, i.e., consumer demand for goods and services, has stalled. From the Fed’s point of view, if a decline in consumer spending results in lower inflation, the trade-off is worth it.

But what about the Fed’s impact on the housing market…

In 2022, the interest paid on a 30-year mortgage doubled as a direct result of the Federal Reserve’s hikes. In response, housing prices were expected to fall. But while the growth in prices has slowed, overall home prices have not dramatically declined like they did from 2007-2010. Unlike that earlier period, a side effect of higher mortgage rates has been the reluctance of many homeowners to put their houses up for sale. Why trade a 3% mortgage rate for one 6% or higher, particularly if you plan to stay in the same school district? The lack of supply has been the main factor keeping home prices elevated despite the rise in mortgage rates.

High prices, lack of new supply; it isn’t just the housing market that is sending mixed signals…

Institute for Supply Management (ISM) manufacturing data – considered to be some of the most reliable economic barometers of the U.S. economy – has taken a turn down across the board since 2021. Specific ISM data, such as new orders (shown above), have plummeted to levels last seen during COVID and the Great Recession. In sharp contrast, however, non-residential construction spending, specifically for manufacturing, has been exceptional. Typically, when new orders fall, companies pull back on capital expenditures and decrease their manufacturing capacity so as not to be caught with excess inventory. Instead, the opposite may be happening, implying businesses do not want to miss out on any pending recovery.

Contraction? Expansion? As businesses try to plan, what signal is the U.S. consumer sending…

The personal savings rate of the U.S. consumer spiked to all-time highs during the first wave of COVID, fueled by government stimulus payments, pandemic loans, and initially the general inability to spend money on much of anything (including toilet paper). Savings rates have now retreated to their lowest levels since the Great Recession, making it just a matter of time until reserves are gone and the consumer is tapped out. However, at the same time, a tight labor supply since 2020 has led to above-average wage growth for American workers, which now outpaces inflation for the first time in years. This wage growth could continue to drive additional spending in excess of what economists have forecasted in the short term.

At Mitchell Sinkler & Starr, we continue to advise our clients to look beyond this present uncertainty and focus on investing for the long term.


Economic and Capital Markets Data

GDP Data as of March 31, 2023; Federal Funds Rate is Lower-Bound
Sources: U.S. Federal Reserve, Bloomberg Finance L.P.


Quarterly Charts

The first half gains in the S&P 500 index were driven primarily by a small handful of large technology stocks. If the rally is going to continue, it probably needs to be more broadly based. Such increased breadth would imply strength in other industries and sectors of the market (and therefore the economy).


The stock market is primarily a forward-looking indicator. While economists forecasted an expected recession in late 2023 (now apparently pushed back it into 2024), the market may already be looking beyond this, to potential growth which might follow any modest economic contraction.


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