Weekly Investment Update (02/09/2024)

Federal Reserve Chair Jerome Powell has received attention in recent weeks due to comments about the timing of potential interest rate cuts, stating, “I don’t think it’s likely that the committee will reach a level of confidence by the time of the March meeting.” Some of Chair Powell’s hesitation may have been driven by the impending Bureau of Labor Statistics (BLS) annual revisions to the Consumer Price Index. While typically not a market moving event, these revisions for 2022 were significant in 2023. Last year, the three-month annualized change in core CPI for December 2022 increased to 4.3% from 3.1% after the revisions. This came as a surprise, so this year the Fed had little incentive to double down on March rate cuts when the recent trajectory of inflation could be called into question by approaching annual revisions.

The BLS revisions were published on Friday, confirming last year’s progress toward lower inflation. Fourth quarter CPI was unchanged at 3.3% annualized. December CPI was revised down by a tenth of a percentage point to 0.2%, and December core CPI remained unchanged at 0.3%. These benign CPI revisions combined with a decline in the Atlanta Fed Wage Tracker to 5.0% from 5.2% in December should begin to provide the Fed with the additional confidence it needs to ease policy. We continue to expect three to four rate cuts this year as the economy slows but continues to grow in absolute terms.

U.S. Economy Remains Resilient Despite Elevated Interest Rates

What is happening: U.S. economic growth has remained resilient with real GDP in 2023 rising 2.5% year-over-year despite the Federal Reserve hiking interest rates by 525 basis points from March 2022 to June 2023. Consumers and businesses appear to be more insulated from rising interest rates this hiking cycle relative to prior cycles, or perhaps the lags in hiking are longer. For the consumer, increased household fixed rate debt exposure in conjunction with increased excess savings during the pandemic has helped sustain consumption. Notably, adjustable-rate mortgages as a percentage of total mortgages fell from 37% pre-GFC to 6% currently. On the business side, S&P 500 company cash balances are 40% above pre-pandemic levels, and many large companies were able to lock in low interest rates for company debt during the pandemic via fixed-rate, long-dated bonds.

Looking at more granular data, it is clear that lower-income consumers and smaller businesses are starting to feel the pinch. Subprime 60-day auto loan delinquencies, which are typically associated with lower-income groups with lower credit scores, have now reached record highs. Moreover, the National Federation of Independent Business’s (NFIB) small business survey, which reflects a sample of 10,000 small-businesses, shows that the average interest rate paid on short-term loans has reached 9.8%, its highest level in the last 10 years.

Why it matters: Resilient economic growth combined with declining inflation is favorable for financial markets. The decline in inflation should encourage the Federal Reserve to cut interest rates this year, and historically, non-recessionary interest rate cuts have led to positive market returns over the next six months. Although economic growth is likely to slow in 2024 given the lagged effects of monetary policy, we view this as a downshift in economic growth from high levels rather than an imminent recession. Continued economic growth alongside declining inflation should continue to support company earnings. Bessemer’s portfolio managers have reduced exposure to more cyclically oriented sectors that are more sensitive to changes in economic growth.

Services Spending Continues to Fuel Economic Growth

What is happening: The current economic landscape has shown remarkable resilience with the ISM Services Index rising from 50.5 in December to 53.4 in January, a notable jump that surpassed consensus expectations. The various components of the index were positive as new order growth expanded at a faster pace than in December, employment growth returned to expansion, and survey respondents indicated future optimism on business conditions.

Some forward-looking indicators suggest that service strength has not yet been exhausted. For example, daily TSA airport passenger throughput averaged a higher level in January 2024 relative to January 2023. This week, Bessemer portfolio holding Hilton Worldwide Holdings (HLT) reported earnings, beating estimates and delivering guidance ahead of expectations, driven by continued recovery in business travel coupled with steady leisure demand. While demand has continued to improve with occupancy rates reaching 2019 peak levels, Hilton expects demand to normalize toward the end of the year.

Why it matters: Consumption patterns have been an important driver for the economy as well as portfolio positioning. Looking back at 2023, we expected services consumption to outpace goods consumption, and while this scenario played out, the strength seen in services consumption has exceeded even our optimistic expectations. Strong services consumption supported economic growth in 2023, contributing an annual one percentage point boost to GDP.

Looking forward, we expect the consumption mix between goods and services to come into better balance as leisure demand normalizes from elevated levels. While a still strong labor market should continue to support service consumption, we expect some moderation from current strong levels as pent-up demand from pandemic lockdowns fades. Bessemer’s All Equity Portfolio is overweight hotels, restaurants, and leisure relative to its benchmark, as a strong and normalizing services side of the economy should benefit these sectors.