Thursday, August 27, 2023

• The U.S. economy grew 1.1% annualized in the first quarter, the third consecutive downshift in quarterly growth.
• Consumers started the year on strong footing as spending on both goods and services added to headline growth. But higher frequency data tell us that consumers have started to slip.
• The biggest drag on overall growth was a decrease in inventories as businesses prepared for weaker demand in the latter part of this year. The good news is if the economy does slide into recession, businesses will not likely have bloated inventories during a downturn in demand.
• The backward nature of the GDP report is possibly misleading for markets as we know consumers were still spending in January, but since March they have pulled back as they get more pessimistic about the future. The latest consumer confidence report corroborates that thesis.
• Bottom Line: The U.S. economy is likely at an inflection point as consumer spending has softened in recent months. The data is setting the Federal Reserve (Fed) up nicely for next week’s meeting. As growth and inflation slow, the Fed can legitimately transition to a pause and then perhaps an outright cut in rates by the end of the year if the economy dramatically weakens.

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Out of Sync

The economy slowed in the first quarter of this year and leading indicators suggest further slowing in the balance of 2023. Investors should know, however, that equity declines do not always line up with recessions. The S&P 500 was up quarter over quarter in Q4 1990 and Q1 1991 when the economy was in recession. The equity markets declined in Q3 1990, before the recession started.

Since markets and growth are sometimes out of sync, our Strategic and Tactical Asset Allocation Committee (STAAC) view is equity markets will not likely retest last year’s lows despite rising recession risks. That said, the path to the end of the year could be rocky, especially with potential unexpected shocks that may come out of Washington, D.C., Europe, or China.

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Conclusion

We think the U.S. is poised to slip into a mild, short-lived recession later this year. The head fake from last year’s two quarters of negative economic growth and the uncertainty from an aggressive Fed were primary culprits for pushing down the markets last year. Although 2023 has its fair share of risks, we do not think markets will retest last year’s lows, despite the likelihood of a recession later this year. Perhaps the relationship between the equity markets and the 1990-91 recession is most informative for the current outlook.

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