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The C-Brief: The 2023 Market Outlook So Far
While leadership teams in every business naturally focus on internal metrics, they also need to be cognizant of domestic and international economic trends and how they may impact their businesses. Supply disruptions and mandated business closures in the early days of the pandemic provided the most dramatic evidence that the global economy is interwoven.
Now, geopolitical risks and recession worries dominate the concerns of business leaders.
“Chief financial officers, like most Americans, have expected a recession since May of 2022," said Paul Single, managing director, senior economist and senior portfolio manager for City National Rochdale, City National Bank's investment advisory organization. “Around that time, gas prices were up, food prices were up and the Fed was ramping up its rate increases. But none of that was a recession."
In fact, Single said that the U.S. economy overall did really well in 2022. The year saw 4.8 million people get hired, the largest increase in history aside from the pandemic rebound.
In addition to reviewing the outlook for a mild recession in 2023 and other domestic economic indicators, Single has insights into global economies, geopolitical risks, what's driving the cost of labor, financial risks for businesses and the availability of capital.
Recession Risks: What Indicators Suggest
Stock market volatility adds to economic uncertainty and the perception that the U.S. economy is weak but, as the well-known economist Paul Samuelson joked in 1982, “the stock market has predicted nine of the last five recessions."
“For a century now the National Bureau of Economic Research has told us precisely when the U.S. has entered a recession and when it ends based on a declining GDP and other metrics," Single said. However, he noted that announcement is usually delayed for an average of seven months after a recession starts.
“While we anticipate a recession later this year, we believe it's likely to be a mild recession because nothing in the U.S. economy is broken," Single said.
A mild recession is anticipated to be an outcome of the Fed's “higher for longer" policy of keeping interest rates high to lower inflation by slowing the economy. But Single does not anticipate widespread layoffs.
Consumer Behavior Is Changing
In addition, a mild recession is a natural outcome of people returning to pre-pandemic behavior.
“Before the pandemic, people were thrifty," Single said. “After the pandemic, people were willing to spend more after being shut down at home. Plus, there isn't any extra money from the government's pandemic subsidies anymore. People are more frugal with the money they earn."
Both consumer spending and business investment, which are already slowing, are likely to slow further in the summer, Single said.
The 2023 Market Outlook
Stock market volatility has rattled investors and created uncertainty for business owners. City National Rochdale's investment team doesn't believe the bear market is entirely over, but it's closer to the end of the cycle than the beginning, in their view.
Historically, no bear market has ended before a recession began. In addition, the average bear market in the post-World War II economy has lasted 16 months and the current bear market is in its 14th month. The average bear market decline during the period was 28% and currently the bear market is down 25%.
While further volatility is forecast in the coming months, sustainable stock returns should fall into place during the second half of 2023. Overall, Rochdale estimates moderate annual returns of 5% to 7% for balanced portfolios with stocks and bonds.
United States Inflation
The Fed's mission since March 2022 has been to slow the rate of inflation by raising the federal funds rate incrementally. Since raising rates didn't get a fast enough or deep enough reduction in inflation however, the Fed has continued to raise rates to above the “neutral rate" and is now up to 4.875%.
“The neutral rate is just a theoretical number, a 'just right' interest rate that keeps inflation low while keeping the economy going," Single said. “After multiple federal funds rate increases, the Fed is now in the fine-tuning stage to figure out what's an adequate rate. We think the Fed will likely stop at the 5.125% level because they don't want to overtighten."
Single expects the Fed to accomplish its goal of getting inflation toward the 2% or 3% range and then stop tightening.
Global Inflation & Outlook
Inflation isn't just a problem in the U.S. Europe continues to have high inflation and slowing growth, and the European Central Bank has been behind the curve in raising interest rates to reduce inflation, Single said.
“Fortunately, Europe has had a mild winter, which buffered some of the expected impact from high energy prices from the war in Ukraine," Single said. “Tourism has also been strong, which helps. But it's still not a great growth story in Europe."
The U.K. has struggled since Brexit, Single said, with its currency down 4% and its stock market up just 7% during a period in which the U.S stock market doubled in value.
“China's big move to reopen their economy and lift their Covid restrictions is big news, but the fundamental problems in China still exist," Single said. “The Chinese people don't have a safety net like unemployment insurance or Social Security, which helped Americans survive the pandemic shutdown. China also has some serious real estate issues."
What Recent Bank Failures Might Mean for the Economy
According to Single, recent developments in the banking industry support City National Rochdale's outlook of a mild recession.
"The fallout from events in banking will likely result in a further tightening in credit conditions across the industry and a lowering of consumer confidence, despite the steps taken by government officials and the Fed," said Single.
He predicted that the fluid situation in banking will combine with still-elevated inflation to really test consumers in the coming months.
"We remain of the view that the banking system is on solid footing and able to withstand this situation. Broadly speaking, U.S. banks are well-capitalized," Single added.
Will a Recession Trigger Mass Layoffs?
A sign of strength in the U.S. economy is the continued low unemployment rate, which was 3.6% in February, one of the lowest rates in the last five decades.
“Most of the layoffs we've seen are in media companies and tech companies, both industries that hired a lot of additional staff during the pandemic and are now returning to normal," Single said.
Single anticipates the mild recession will lead to an increase in the unemployment rate, but he doesn't expect an extreme number of layoffs.
Currently, the fields with the most job openings are hospitality, healthcare and education, all of which experienced either more extended shutdowns and losses or higher levels of employee burnout during the pandemic, Single said.
What Labor Costs & Unemployment Mean for Employers
Wage growth has been higher in the post-pandemic economy because the economy is stronger and people left the workforce, which means employers must compete for employees, Single said.
“Most of the wage gains have been at the lower end of the income spectrum in fields such as transportation, hospitality and retail because that's where the most job openings are," Single said.
The Fed would like to see the annual change in hourly earnings grow at a pace of 2.5% to 3.5%, which it believes is in line with the targeted inflation rate of 2%. In January, average hourly earnings continued to slowly fall to 4.4% year-over-year. The revised December rate was 4.8%.
While that is good news for the Fed, the decline in wage growth could be skewed by a large amount of hiring at the lower end of the income spectrum, such as hospitality workers, Single said.
Labor participation rates increased in January to 62.4%, the highest level since March 2020 but still nearly a percentage point below the pre-pandemic peak of 63.3%. If this higher participation continues, it could reduce the imbalance between the 11 million job openings and 5.7 million people looking for work.
Asset Allocation Outlook
The recession and unemployment numbers are changing the ways that companies approach asset allocation in 2023.
In anticipation of the mild recession ahead, business leaders are already cutting back on their spending and preserving cash, Single said.
“CFOs are cutting back on other spending and limiting labor hours and overtime, but they want to hold onto their labor," Single said. “They don't want to find themselves in the position and cost of needing to hire when the mild recession ends."
Most companies are in a good position with the employees they have in place and are not likely to reduce costs in the form of widespread layoffs, although some will be necessary, Single said.
Business Risks for 2023
The two biggest risks for business owners are inflation rates and demand for labor, Single said. Higher interest rates and access to credit are also a growing concern.
“If inflation doesn't slow down fast enough, the Fed could raise rates even higher," Single said.
While inflation continues to decline, it's at a slower pace than it was earlier in this economic cycle. Higher interest rates continue to pressure consumers and businesses and are causing compression in profit margins for many companies.
“The unbelievable demand for labor is a challenge for businesses," Single said. “In this strong economy, employers are doing what they can to hold onto their workers, but as the economy weakens, it may become harder to keep them."
Geopolitical risks and the lingering impact of supply chain disruptions make it more important for business leaders to be aware of their inventory.
“They need to be clear about where their parts are coming from, where their inventory is now and where it will be in future because that could add costs," Single said. “The supply chain disruptions have faded because the issues have been worked through and demand isn't as high."
Energy costs were a big issue from February through June 2022 because of the Ukraine war, but Single doesn't anticipate high energy costs to be a long-term issue.
“Most U.S. companies are moving to green technology and as the world moves away from carbon-based energy, demand will slow," Single said.
What Does Geopolitical Instability Mean for Companies?
Business leaders need to be aware of the potential impact of geopolitical risks on their industry and the global economy.
“Geopolitical risks are at an extreme level now, with everyone watching to see if China helps Russia in exchange for cheap oil," Single said. “China and U.S. relations are a problem, too, which has brought more attention to the issue of why our chips and other strategic products are made in China."
Companies are now trying to move manufacturing away from China.
CFOs typically watch commodity prices, most of which are priced in dollars, Single said. Demand isn't high enough for dramatic change in commodity prices, he said.
Assessment on Capital Markets in 2023
Both venture capital and private equity funding fell dramatically in 2022 and are likely to remain limited in 2023, Single said. Banks are also being more restrictive on commercial and industrial loans.
The Fed's consistent increases in the federal funds rate are beginning to be felt by personal and business borrowers.
“Interest rates are now a bigger part of the decision people make before taking out a mortgage or a car loan or charging something to their credit card," Single said. “It's slowing down the rate of personal borrowing and slowing down business borrowing of commercial and industrial loans."
Businesses that have a strong relationship with a bank may be in a better position to borrow, Single said.
“Businesses can still get a loan, but the terms are shorter, loan covenants and collateralization requirements are tighter, and the size of credit lines is reduced," Single said.
As a result, demand for credit has slowed, which will contribute to slowing economic growth over the next several quarters.
“Essentially, the outlook for business is that they just need time," Single said. “At some point the Fed will begin easing rates, the stock market will generate steadier returns and the economy will strengthen again."
The Stages of Business Growth
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