Weekly Investment Update (07/14/2023)

The Economy and Markets Have Been Remarkably Resilient so Far This Year

The first half of 2023 has seen a striking resilience of the economy and markets in light of the continued reverberations of last year’s shocks. While the economic backdrop is not extremely robust, it is meaningfully better than many of the dire scenarios that became consensus in 2022. Economic activity is slowing; however, we continue to believe that a severe recession will be avoided. Encouragingly, inflation continues its downward trajectory in spite of a persistently imbalanced labor market. While the labor market remains tight, we are beginning to see signs of rebalancing. These factors lead us to believe that the Fed is close to finishing its hiking cycle. Even though the Fed is likely to keep rates high as long as it can, we expect it to respond should the economy show vulnerability.

Although macroeconomic uncertainties linger, we believe that high-quality companies will continue to compound earnings in this environment. Accordingly, slower growth and a high cost of capital make security selection even more important. Bearish investor sentiment has lingered for much of the year; consequently, positioning remains skewed away from risk assets in favor of cash. Dynamics suggest that markets can continue to move higher as economic growth persists, albeit at a slower pace. For additional commentary on the economy and markets, as well as a closer look at a key structural growth theme, semiconductors, please see our latest Quarterly Investment Perspective.

Disinflationary Trend Remains Intact

June’s inflation report signaled a continued easing of inflationary pressures with analysis of the underlying components suggesting that disinflationary trends remain intact. Both headline and core inflation came in below expectations, with headline easing to 3.0% and core easing to 4.8%. Though core CPI inflation has remained sticky, this marks the first reading in seven months that it moderated more than expectations. Shelter was the largest contributor to remaining month-over-month increases; however, the pace of acceleration continues to slow. Notably, core services excluding housing, a metric in focus for the Federal Reserve, was flat on the month. This marks the first alleviation in service price pressure since late 2021. Furthermore, forward looking indicators across goods, services, and shelter continue to point to easing price pressures.

Notably, core services excluding housing, a metric in focus for the Federal Reserve, was flat on the month. This marks the first alleviation in service price pressure since late 2021. Furthermore, forward looking indicators across goods, services, and shelter continue to point to easing price pressures.

While the market continues to price in an interest rate hike in July, expectations for an additional hike at the September meeting declined marginally. With the first phase of disinflation encouragingly underway, the next phase of declines necessary to return to the Fed’s 2% target could prove more challenging. Base effects that have aided the disinflationary process over the past year will provide less of a tailwind to lowering inflation over the coming months. Despite continued stickiness in the shelter component, we expect inflation to continue its downtrend even as it is likely to take some time to reach the Federal Reserve’s 2% target.

Treasury Secretary Yellen’s China Trip Reestablishes Economic Dialogue

Treasury Secretary Janet Yellen’s trip to Beijing was largely seen as a success given the resumption of high-level economic dialogue between the world's two largest economies even as tensions remain between the two superpowers. Secretary Yellen’s visit comes on the heels of Secretary of State Antony Blinken’s visit last month, in a continuation of the mini thaw between the two nations. China’s lackluster economic growth thus far in 2023 is likely a contributing factor behind its interest in improving bilateral relations. The government is likely seeking a measure of international stability as it focuses on domestic challenges.

During her meetings, Secretary Yellen pressed the Chinese government on what she called the "breadth and depth of China’s non-market policies, along with barriers to market access for foreign firms and issues involving intellectual property." For Beijing, top issues raised included the tariffs imposed by the Trump administration and export restrictions on advanced semiconductor technologies imposed under the Biden administration. However, a reversal of these U.S. policies remains unlikely in the near term, in our view, given the proximity of the 2024 presidential election cycle. Secretary Yellen concluded her trip with remarks that "the world is big enough for both of our countries to thrive" and that the Biden administration seeks "healthy economic competition."

We view the reestablishment of high-level economic channels between the two governments as a positive for global economic and market stability. The growing yet fragile momentum building between the two governments could pave the way for President Biden and President Xi to meet later this year. This is possibly their last opportunity to do so before presidential elections in both the U.S. and Taiwan next year. The Bessemer investment team will continue to monitor developments in the critical G2 relationship and any potential impact on portfolio holdings.