We have had several conversations with clients who have expressed interest in the current economic climate. Here are our thoughts on some of the key economic issues you may have seen in the news. There have been some bank failures, inflation is still in play, the labor market is very tight, and the Fed interest rates are still rising at one of the fastest paces in history. Yet, the economy is still strong. So, what should we be looking at?
First, let’s look at the news of the day – Banks. The overall Bank capital ratio stands at about 13.7%, well above the 10-11% seen prior to 2011, and in line with the 13% seen since then. That’s good. Still, banks are likely to tighten up their lending standards, lending only to higher credit customers with more profitable projects. It’s worth noting that a sizeable percentage of deposits are being lured away from checking and savings accounts to money market funds and Treasuries since these instruments pay 2-4% higher yield. The net effect is that banks have fewer deposits to fund loans that they might make, especially business and commercial real estate loans, hence the expected tightening.
image source: JP Morgan Guide to the Markets Q1 2023, page 25.
Will there be a recession? Maybe. I continually contend that most people care about whether they will be in a personal recession or not. However, broad trends are at play at a national level, which may or may not actually reach the consumer level. One trend is companies are likely to have flat or maybe lower profits this year. Due to the lending tightening above, growth projects that looked good when funding was 4%, don’t always look as good at 7% or more. A second trend is housing which is still finding its new equilibrium. There isn’t enough new construction happening in most places to raise the housing supply. As long as housing supply remains low, pricing is likely to remain elevated. For better or worse, many buyers are priced out of the housing market until more supply becomes available. It’s anybody’s guess how long that may be, but it’s a good bet that a significant number of people will not sell their home with a mortgage at 3% or less to buy another one at 6% or more.
Labor markets are finally cooling off a bit. We are finally seeing a change here with historic unemployment lows, the National rate is at about 3.6%, and the Wisconsin rate where I currently live is around 2.7%). We should expect this to rise somewhat, but there are still more job openings than people to fill them. With baby boomers leaving the workforce, a reduced birth rate, and a relatively low legal immigration rate, we could remain short of workers for quite a while. Overall, we would expect wages to simply grow at a more moderate pace than they have recently.
The Fed has obviously been quite a factor in the status of the economy with the intentional interest rate spike from 0% to 4.75% in less than 12 months. This is one of the fastest interest rate hikes in history, and even though this simply brings us to historically normal rates, the speed of change was a shock to the system. Banks should have prepared for the risk of an interest rate change, and as shown in recent news, we found out that some of them didn’t. We still think the Fed will raise rates a little more, then level off and come down somewhat, which seemingly agrees with Market expectations.
image source: JP Morgan Guide to the Markets Q1 2023, page 34.
Where does all that economic activity leave us in regard to markets and investments? In the short term, it is always difficult to tell, but there are reasons to believe that international equity markets will be attractive in the near- to mid-term.
Disclaimer: Shamelessly stolen from a financial advisor I started working with.