Weekly Investment Update (08/18/2023)

This Week’s Positioning and Views

The nearly 5% move lower in the S&P 500 this month seems at odds with signs of economic stability. However, intra-year equity market corrections are the rule rather than the exception – since 1980 the stock market has experienced a median intra-year drawdown of 10.5%. Currently, investors continue to weigh the delicate balance between economic strength and the future path of interest rates. While weakness in the manufacturing side of the economy has diverged from consumer-driven services strength, some industrial sectors are likely to benefit from increased government and private investment. Targeted allocations to specific companies that stand to benefit from such trends are combined with an overall portfolio exposure that is not overly reliant on a robust economic acceleration. This is reflected in our underweight to the most cyclically exposed sectors within equities and our higher-than-normal duration positioning in fixed income. Finally, we remain focused on the impact that declining economic activity in China, the world’s second largest economy, could have on global growth and markets across the world. 

Manufacturing and Services Divergence Show Early Signs of Normalization

 Consumer spending patterns following COVID-19, among other factors, have led to a bifurcation in the strength of the economy between the manufacturing and services industries. Robust consumer spending on services relative to goods has led to a services sector expansion; meanwhile the manufacturing sector has been in contraction for nine consecutive months given softening consumer demand for goods and higher interest rates. 

Amid a challenging macroeconomic environment, the consumer continues to underpin U.S. economic growth. With consumption comprising around 68% of GDP, positive spending patterns are an important indicator of economic growth, which is highly correlated to corporate earnings. While services spending remains strong, recent earnings and the stronger than expected July retail sales report revealed early signs of normalization in the spending balance between goods and services, with the pendulum shifting back towards goods. The pullback in purchases of big ticket discretionary durable goods persists, but retailers are starting to see increased traffic in stores and strength in smaller-ticket purchases. 

While overall manufacturing has been in contraction, given rotating consumer preferences and higher interest rates, there are pockets within the industry that are seeing strength. Both the most recent monthly construction spending report and this week’s industrial production report showed strength in private construction for computer, electronic, and electrical manufacturing facilities. Strength in these categories is likely reflective of recent government legislation passed with the aim of boosting U.S. manufacturing, including the Infrastructure Investment and Jobs Act, CHIPS Act, and Inflation Reduction Act. 

We expect services spending to remain stronger relative to goods, in part due to continued pent-up demand for travel. Additionally, certain sectors within manufacturing are likely to be supported by increased government and private investment in manufacturing facilities and equipment as well as improved momentum in goods spending. 

Bessemer’s All Equity Model Portfolio maintains positions in companies that Bessemer portfolio managers expect will benefit from the increased government legislation, including Quanta Services, a leading infrastructure solutions provider in the U.S. and other international markets. Targeted allocations to specific companies that stand to benefit from such trends are combined with an overall portfolio exposure that is not overly reliant on a robust economic acceleration. This is reflected in our underweight to the most cyclically exposed sectors within equities and our higher-than-normal duration positioning in fixed income.

More Lackluster Economic Data Out of China

After missing its Q2 GDP expectations last month, China reported more disappointing economic data over the past two weeks. Retail sales, industrial production, and fixed asset investment growth all slowed further from June to July. Property sales also continued to decline, and new home prices fell for the first time this year in July. Additionally, July total social financing (TSF) credit growth came in at 528 billion RMB, which is less than half of what was expected and further highlights weak demand in the economy.

Concerns about China going into a deflationary period rose after July marked the first negative headline inflation rate in more than two years. However, a closer look reveals that the negative headline consumer price index (CPI) is not as alarming because it is largely driven by lower pork prices. Excluding food and energy, July core CPI inflation increased 0.8% year-over-year, helped by strong domestic tourism related services.

While the reported economic numbers were mostly downbeat, there are additional concerning figures that the government did not report. In an unexpected development, the National Bureau of Statistics announced that it will no longer release the unemployment rate for youths between 16 and 24 years old. In June, the youth unemployment rate reached an all-time high of 21.3%. The official reason given for suspending the data release was a need to refine the methodology, but analysts suspect the real reason is because the July youth unemployment rate is likely much worse than the record high set in June. Historically, unemployment for the youth cohort reaches an annual peak in July due to the many university students graduating in early summer.

The Chinese government has announced policy easing measures in response to the latest economic data, including allowing local governments to refinance more existing debt and reducing several benchmark interest rates. The policy easing measures to date have been more incremental in nature and are unlikely to reverse the current overall negative economic momentum, in our view. We believe the government is more focused on mitigating systemic risks than driving economic growth at the moment and is unlikely to substantially loosen policy in the near term. Bessemer’s portfolios hold a benchmark weight in Chinese equities, and the investment team will continue to closely monitor these developments as meaningful weakness in the world’s second largest economy would likely have global ramifications.