Branstad: Hi, everyone. Thank you for joining us today for Thrivent Asset Management’s Capital Markets Perspective. I’m Jeff Branstad, your host for today and a portfolio manager here. I'm joined by Steve Lowe, our chief investment strategist.
So, Steve, let’s start broadly with what’s been going on. The first half of the year was really quite strong for markets, particularly in the equity markets. But the third quarter and into the fourth quarter have seen a lot more volatility.
Lowe: Yeah, that’s exactly what happened. The third quarter was much more challenged for markets. It was down about 8% from the peak for the year and then it rebounded into the fourth quarter.
Branstad: So, what’s been driving that kind of equity softness over the past few months?
Lowe: I think it’s largely the impact of much higher long-term rates in the quarter. And part of that was due to more hawkish Fed expectations – their “higher for the longer” approach. But especially it was what are called “real rates.” So, real rates are adjusted for inflation and those spiked a lot.
There’s a high correlation between real rates and market valuations on both the credit and equity sides. So, a bit of good news is bad news. There are higher rates partly due to the economy, but there’s also concerns that higher rates that are too strong would trigger a more hawkish Fed response. That would hurt the economy and we’d end up in recession.
Branstad: 2023 hasn’t exactly played out how many economists and market strategist were predicting. Can we recap a little bit? How did we get to where we’re at today?
Lowe: Yeah, I think the broad consensus heading into the year was that we would possibly be in a recession by now. We’re obviously not. What you’ve seen is that maybe that call isn't necessarily wrong – it’s just been pushed back into 2024.
I think the economy has been a lot more resilient than people expected. The job market has been strong – that produces income which drives consumer spending. And earnings have held up pretty well, too.
Most corporate and household balance sheets are strong. But upper income brackets are still spending. You’re seeing lower income brackets spending less – they’re a little more challenged and have largely depleted their excess savings from the pandemic stimulus.
But I think it’s important to note that, in transition periods, economies and jobs tend to hold up into a recession. They’ll do quite well and then tip over rather quickly. Also, rates take a long time to impact the economy – it’s 12 to 14 months before the full effect is felt.
Branstad: So, it seems like there’s been some conflicting signals between the consumers and the broader economy.
Lowe: Yeah, there are a lot of conflicting signals. And that’s common, particularly during turning points. For example, GDP and the broad economy have been strong. And, as I just said, spending has been good, wages are solid, payrolls are strong.
There’s a significant deficit of workers – there’s still savings. But, when you look at job openings, they’re starting to fall. Manufacturing has been in contraction for a while, as measured by surveys. Services are better, and that's a large part of the economy.
Small businesses are in a really dour mood right now – confidence is pretty low there. And income is above trend, but if you look at real income – inflation-adjusted income – it’s below the trend from prior to the pandemic.
So, inflation is really taking a bite out of people. Same thing with savings – savings are much lower if you adjust for the impact of inflation. And real spending is soft. You also have these other headwinds, like student loan repayments have started up again, and there’s the auto strike. Gas prices are starting to go up. If you use credit at all, your credit card rate is around 23%, which gets very costly. And delinquencies on things like credit cards and auto loans are going up, as well as bankruptcies.
Branstad: So, you’ve mentioned the soft landing and the “no landing.” What do you think the base case is right now? Will we see a soft landing, no landing, or a full recession? What’s most likely?
Lowe: Yeah, I think the odds of a soft landing have definitely gone up, possibly even no landing. But, as mentioned, we haven’t yet felt the full impact of higher rates and tighter financial conditions. The cost of debt is up very meaningfully, so refinancing is very expensive. Credit is tight.
We still see signals which you’ve mentioned that, in the past, have always worked: leading economic index, the inverted yield curve – we’ve historically always had recessions after that. So, I think the time has just shifted out because the economy has been resilient, but rates will still take their toll over time, as well as tightening financial conditions.
Ironically, if the economy stays too strong, that also increases the chance of recession, because if you get inflation going up, then the Fed needs to raise more.
The war in the Middle East is a bit of a wildcard. We don’t know how that’s going to play out, but it has the potential to send gas prices higher, which would be harmful to consumers.
So, our expectation is that the economy slows in 2024 with the odds of a recession lower than before but still meaningful. A soft landing is still in the mix – or some kind of landing, meaning the economy is slowing.
In the long term, we have a very positive view of the economy for a variety of reasons, like tech, artificial intelligence; long-term CapEx is very strong, as is the investment in manufacturing in the U.S.
Branstad: Well, thank you so much, Steve, for sharing Thrivent’s perspective on the capital markets. And thank you all for joining us today. We’ll see you again soon. Thank you.
Lowe: Thank you.