Economic Outlook Remains Murky
The Fed tightened until something broke: Silicon Valley Bank. Now the Fed has to grapple with maintaining financial stability (and not let anything else break) as it tries to tame inflation.
The outlook for the U.S. economy has become murky—again. First, Federal Reserve Chair Jerome Powell spooked investors on March 7th by suggesting the central bank might need to raise short-term interest rates higher than previously expected to fight inflation. But within days, three bank failures jolted markets and led to speculation that the Fed might instead pause or slow its rate hikes in an effort to ensure financial stability.
This push-and-pull has been an aspect of the economy and markets for months. The U.S. economy added 311,000 jobs in February, following a 504,000-job gain in January. A strong pace of hiring suggests larger and/or more rate hikes will follow this year. But on the other hand, gains in the labor force participation rate (to 62.5% from 62.4%) and the unemployment rate (to 3.6% from 3.4%) indicate that more people are coming off the sidelines, looking for work, and not finding it—factors which argue for a gentler Fed approach.
Slower average hourly earnings growth in February also indicated that the labor market is decelerating. However, the drop in overall wage growth is mostly due to a decline in higher-paying jobs. For nonsupervisory workers’ wages (which are lower), growth has stabilized at just under 5% (at a three-month annualized rate), as hiring remains strong within that group.
The recent Job Openings and Labor Turnover Survey (JOLTS) from the Bureau of Labor Statistics also provided mixed signals. Demand for labor eased in January. At the same time, a lower quit rate is suggesting that workers are less comfortable leaving their job in hopes of finding a new one. While the downward move suggests that worker confidence is ebbing, the rate itself remains high relative to its history.
In other words, uncertainty is returning to the labor market, and the high quit rate that persisted during the pandemic is being replaced by a more cautious and sober attitude in the workplace.
Knowing where to turn for solid investment returns seems particularly challenging in the current environment. Stocks have always been a great place to invest for the long term. However, in the shorter-term, stocks are facing a classic don’t-fight-the-Fed predicament. That is, stocks have historically faced downward pressure during cycles of Fed tightening like the one we are in now.
With the Fed pushing interest rates higher, bond yields have also risen offering investors a modicum of investment yield. But the most attractive yields are found in shorter-term bonds. (i.e. Bonds with maturities of three years and less.)
For example, a one-year Treasury bill currently yields around 4.75%, but a 10-year Treasury yields less than 3.5%. Consequently, bond investors are not able to lock in attractive yields for longer periods of time. Not to mention that neither the one-year, nor the ten-year Treasury, yields enough to keep pace with the current rate of inflation (6.4%).
In an interview with the Wall Street Journal’s editorial page, Paul Singer, the founder of Elliott Management and one of the world’s most notable money managers said the US economy is facing an “extraordinarily dangerous and confusing period.”
Financial markets are facing a slew of obstacles on top of an already difficult macro environment as the Federal Reserve and other central banks continue to hike interest rates to battle stubbornly high inflation.
“Valuations are still very high. There’s a significant chance of recession,” Singer said. “We see the possibility of a lengthy period of low returns in financial assets, low returns in real estate, corporate profits, unemployment rates higher than exist now and lots of inflation in the next round.”
And if the next recession hits, central bankers will ease monetary policy again, thinking that inflation has been conquered, he added. But inflation will come back, possibly even more than before, meaning rates will have to go higher for longer, he said.
Where to Turn?
In uncertain times, diversification remains paramount. Intelligent, reasonable people are predicting seemingly opposite economic outcomes and predicting widely varied expectations for investment returns. Whether 2023 turns out to be a good year for stocks or bonds seems anyone’s guess.
That said, SilverPeak Wealth believes there are alternative investment classes like private credit and select areas of commercial real estate (industrial and residential) that can further diversify a portfolio while offering higher dividend income than most stocks and bonds.
Put a different way, SilverPeak Wealth will employ alternative, higher-yielding investments (in a diversified manner) in an effort to keep portfolios earning a positive return while the stock and bond markets churn through the current malaise.