Asset TV Insights

2023 Mid-Year Outlook Masterclass

In a recent discussion at the Asset TV 2023 Mid-Year Outlook Masterclass, finance professionals Tom Ognar, Senior Portfolio Manager and Growth Equity Team Manager at Allspring Global Investments , Kathryn Rooney Vera, Chief Market Strategist at StoneX Group Inc. , and Jeffrey Schulze, Head of Economic and Market Strategy at ClearBridge Investments , gathered to explore critical topics that are shaping the financial landscape for the second half of the year. Here are some key takeaways and insights:

The Market Disconnect

The conversation began with a striking observation made by Kathryn Vera, she pointed out a perplexing disconnect between the stock market's performance and economic reality. Despite concerns about slowing economic growth and persistent inflation, equities, particularly in the tech sector, have been on an impressive uptrend. The NASDAQ, in particular, has stood out as a high-performing index. Kathryn also highlighted the inverted yield curve, which traditionally signals an impending recession but seems to have little influence on the equity markets. She also noted that the Federal Reserve's pursuit of a 2% inflation target appears to be met with skepticism by the market.

The Recession Outlook

Jeffrey Schulze shared his view that a recession is looming, likely in the latter half of the year. He referred to his proprietary recession risk dashboard, which has been signaling caution for some time,  and highlighted a deceleration in the U.S. economy in the coming months, supported by data like the 13 consecutive months of declines in the Leading Economic Indicator Index.

While many anticipate a short and shallow recession, Schulze offers a different perspective, suggesting it might be more moderate and prolonged, possibly ranking at a four or five on a scale of one to ten. He attributes this to the Federal Reserve's changing reaction function, which aims to avoid the mistake of loosening into a tight labor market, potentially leading to long-term inflation issues. Schulze emphasizes that the Fed's expectations of job losses and their cautious approach to rate hikes and cuts reflect their concern about controlling inflation.

The reason why the Fed is acting as hawkish as they are, even with some signs of deterioration and potentially a recession, the reason why they are doing this is they don't want to repeat the sins of the FOMC of the 1960s. Jeffrey Schulze

Kathryn shares her agreement with Schulze and adds that the Fed has faced challenges of its own making. She points out that the Fed's past decisions, such as extending quantitative easing longer than necessary, have contributed to the current complex economic environment. Kathryn highlights the Fed's difficulties in forecasting inflation and expresses concern about their data-dependent approach. She emphasizes the importance of the Fed achieving its 2% inflation target and suggests that changing that target or cutting rates prematurely would harm the Fed's credibility as an inflation fighter. Kathryn also takes a cautious stance on equity markets, citing concerns about overvaluation and narrow breadth. She points out that if we're indeed entering a recession, it may not bode well for equities, highlighting that although investors have largely experienced the Goldilocks phase with low inflation and high growth over the last few decades, she believes we might be transitioning into a less favorable phase. For dedicated equity investors, Kathryn suggests exploring sectors historically known to perform well in stagflation and recession, such as staples, healthcare, and utilities. Additionally, she recommends considering tactical plays and emerging markets, offering alternatives for those looking for opportunities.

Real Estate's Surprising Strength & Labor Market Concerns

One notable sign of strength in the current financial landscape is the real estate market. U.S. housing starts unexpectedly rose by a significant 21.7% in May, a development that piqued the interest of market participants. This unexpected surge in housing starts, as explained by Kathryn, is a response to the high demand and low supply dynamics in the market. While housing demand remains robust, the surge in mortgage rates has made buying a new house or selling an old one less attractive for many. Some might label this trend as deflationary, but Kathryn believes it's more a result of excess demand. She emphasized the importance of the labor market in this context, where people with jobs are experiencing wage increases. Kathryn argued that, given the current trajectory, the Fed may find it challenging to achieve its 2% inflation target.

Jeffrey Schulze highlighted concerns in the labor market despite headline job numbers surpassing expectations. He pointed out the divergence between the establishment survey (business data) reporting 339,000 positive jobs and the household survey (individual data) reporting a negative 310,000 jobs. Such disparities, though common, can be pivotal at turning points. Job sentiment, derived from the Conference Board's consumer confidence survey, is declining, indicating potential labor market deterioration. The ongoing decline in hours worked also raises concerns, possibly reflecting reduced employer demand.

Tom Ognar posed a thought-provoking question. If the labor market data continues on its current trajectory, wouldn't this suggest that the Federal Reserve should pause its rate hikes? Jeff's response emphasized the Fed's commitment to preventing inflation from spiraling out of control. The Fed might need to take more action, even if the data suggests a slowing economy.

(...) I think there's going to be a lot of psychological pressure coming down from politicians every day in the press on the Federal Reserve to take into account those Americans that are hurting from their policies or potential policies. And I'm not saying that that would be the right thing for the Fed to do, but I think it's realistic for us to actually look at that and understand that the Federal Reserve is going to be under a lot of pressure trying to work its way out of this structural inflation that we've had. Tom Ognar

Fiscal Policy's Role

Kathryn highlighted the significant role of fiscal policy in contributing to inflation, particularly with the U.S. fiscal deficit at 6% of GDP. She emphasized the need for fiscal and monetary policies to work together effectively to address current economic challenges. The interaction between fiscal and monetary policies is crucial, as the substantial fiscal deficit, combined with measures like quantitative easing, raises concerns about future inflation dynamics.

(...) I think the argument that you do have countries around the world who would like to move off the US reserve currency is completely accurate, I just don't think there's an alternative and I don't think it's coming soon. Tom Ognar

Equities as Inflation Hedge

Tom offered a unique perspective on asset allocation. While acknowledging the importance of diversification, he highlighted that equities, particularly growth stocks, can serve as effective inflation hedges. Equities have the flexibility to adapt to changing economic conditions. Tom emphasized that companies like McDonald's and Coca-Cola can adjust prices while remaining attractive to consumers, making equities a valuable asset class in times of inflation. Tom adds another layer to the discussion by focusing on companies that are poised to benefit from the productivity gains associated with AI. He suggests that investing in companies creating the tools and technology needed for AI implementation could offer significant opportunities. Tom recognizes that while eventually, certain companies will emerge as winners in the AI arena, it's challenging to pick them at this stage. Therefore, investing in the "arms dealers" of AI, companies creating the essential infrastructure, could be a wise strategy in the near to medium term. Tom also highlights the potential for small and mid-cap stocks to regain leadership when the Fed eases and interest rates decrease, signaling a potential shift in market breadth.

Conclusion

In a world of complex economic dynamics, these finance professionals offer valuable insights into the current financial landscape and the challenges and opportunities that lie ahead. As we navigate the uncertainties of the second half of 2023, their perspectives serve as valuable guides for investors and decision-makers alike. Whether it's understanding the market disconnect, assessing the risk of recession, or exploring innovative investment opportunities, their wisdom provides a compass in these ever-changing financial waters. Stay informed, stay diversified, and stay adaptable, for that is the path to financial resilience in any economic climate.

As we wrap up this enriching discourse, remember that the 2023 Mid-Year Outlook Masterclass offers a deeper dive into these insights. Stay tuned, stay informed, and master the art of investment in the ever-evolving landscape of emerging markets.

If you like this content check out more at Asset TV for a comprehensive exploration of these expert perspectives.

*Disclaimer: The views and opinions expressed in this article are for informational purposes only and do not necessarily reflect the opinions or positions of Asset TV. The information provided is based on Asset TV’s 2023 Mid-Year Outlook Masterclass and should not be interpreted as professional advice or guidance. It is always recommended to conduct thorough research and consult with relevant experts or professionals before making any financial, investment, or business decisions.