Quarterly Economic Review: Third Quarter 2023

Key Takeaways

• Global economic growth has remained resilient during this rate hiking cycle. Near term growth, although moderate, is now trending towards an economic slow down as most major economies seek to reduce high levels of inflation.
• Within the U.S., monthly inflation has nearly returned to trend and job creation continues to support economic growth.
• U.S. equity markets, which fell moderately during the quarter, remain ahead for the year but equity returns have been driven by a small group of names.
• The average S&P stock is reasonably priced, trading at a P/E of 14x.
• Fed policy makers are forecasting a ‘soft landing’ for the U.S. economy with growth moderating and inflation falling.
• S&P 500 is priced more opportunistically with valuations and volatility levels implying a ‘no landing’ scenario.
• Fixed income markets are priced for ‘no landing’, given tight credit spreads across corporate and municipal bonds.
• Though recession talk abounds, no asset category is priced for a ‘hard landing’.
• Private markets continue to gain assets, provide broad exposure to critical market segments and offer strong potential to offset public market risk and generate stable levels of income.
• ‍Global economic policy uncertainty, which was already running near records highs, increased further with the outbreak of war in Israel. The U.S. will need to make decisions on providing aid as it runs its largest ever peace time debt and deficit burden.
• A reshuffling of the global order, which has seen dramatic changes in global trade, regional alliances, cyber warfare and manufacturing production is now likely to experience even further upheaval.

The Economy

The U.S. economy, per the GDPNow forecast from the Federal Reserve Bank of Atlanta, is on pace to grow near 5% in Q3 2023. The rate of growth is far in excess of the 0% projection from Wall Street economists at the beginning of the quarter and well above the Fed’s target. Growth was driven by strength in retail sales, construction materials, software/AI and investments in renewables infrastructure. However, higher growth today is coming at the expense of future growth tomorrow as forecasts for Q4 2023 and calendar year 2024 are being notably reduced. Headwinds include higher rates for mortgages, resumption of student loan repayments and the expiration of a short-term government funding bill which will likely lead to tighter fiscal policy.

Inflation continues to decline but remains above the Fed’s 2% target. Core PCE, the Fed’s preferred measure, is running at 3.9%. According to the Fed’s internal forecasts, core PCE will fall to 2.6% by calendar year 2024 and return to target by calendar year 2026. The Fed intends to reduce its policy rate from restrictive to neutral in tandem with this decline.

The U.S. labor market remains strong (see below). Nonfarm payroll growth, while slowing, remains supportive of economic growth and initial claims as a percentage of the labor force are running at historic lows. An increase in work stoppages and recent labor settlements are driving wages higher. While too early to worry about a wage-price spiral, the Fed needs to consider medium-term risks to inflation if wage growth accelerates and moves above trend.

Eurozone growth, despite running negative in Germany, has actually held up well given the backdrop though it is now expected to reach 0% for H2-23 and Q1 2024. Emerging markets continue to grow near 6% with India and the Asia Pacific region showing the most strength. China is forecast to grow 4% next year, though only 1% for the upcoming quarters. Japan is forecast to slow from 1.8% growth this year towards 1% next year.