Weekly Investment Update (08/31/2023)

This Week’s Views and Positioning

Although overall economic data continues to surprise to the upside, some key data has recently come in below expectations. Counterintuitively, weaker economic data may be a good thing for stocks in the near term. Indications of slowing growth and a loosening labor market will provide support for the Fed’s belief that “the current stance of policy [is] restrictive, putting downward pressure on economic activity, hiring, and inflation.” Although an increase in positive economic surprises has called this narrative into question, recent signs of labor market rebalancing likely provide enough evidence for the Fed to refrain from further rate increases.

However, only so much economic weakness will be tolerated by equity investors. An increase in the S&P 500 Index’s price-to-earnings ratio (rising from 16.7 to 18.8 this year) has been the primary driver of equity market returns in 2023. Going forward, stable economic growth would likely be required to support the somewhat lofty 12% earnings growth forecast for the next 12 months.

We expect a persistent, yet controlled, economic slowdown to unfold in the coming quarters. We do not anticipate a severe recession that would lead to a significant contraction in earnings expectations; however, current earnings estimates are likely too high to be consistent with the future path of economic growth. As a result, we maintain our overweight to equities but favor exposure to higher quality U.S. companies and sectors that are less exposed to an economic growth slowdown — technology and healthcare, for example. Within fixed income portfolios, we favor above-benchmark duration, allowing us to capture yields that may be close to their peak.

Is Bad News Good News?

What is happening: Economic growth has been stronger than expected by most economists year-to-date, though recent key data indicates it may be slowing back to trend. Bloomberg’s U.S. economic surprise index, which measures the difference between economic data releases and analysts’ forecasts for the releases, increased to its highest level in over two years in July. On Tuesday, newly released data showed that job openings in July came in below expectations with 8.8 million job openings compared to an expected 9.5 million openings. Additionally, consumer confidence as measured by the Conference Board declined by more than expected in August, dropping to 106.1, the lowest reading since February 2021. As a result, Fed Fund Futures reduced expectations for an additional rate hike in November, pricing in a 45% chance on Wednesday, down from a 70% chance on Monday.

Why it matters: Equity markets appear to have returned to the adage that bad news for the economy is good news for the stock market. On days that the economic data surprised below expectations over the past several weeks, the market rallied. This reflects the markets’ attempt to balance positive and negative dynamics and tells us equity market risk lies in both the weakest and strongest extremes of economic growth. Above trend economic growth benefits corporate earnings, though it may also drive the Federal Reserve to raise interest rates, which could pressure equity market valuations. Federal Reserve Chair Powell described monetary policy last week in Jackson Hole as sufficiently restrictive to deliver below-trend economic growth, and recent data prints likely provide enough evidence to keep rates steady.

While we continue to believe that a controlled slowdown will unfold in the U.S. economy, we are closely watching for signs of persistently above-trend growth or a significant deterioration in the economy. Currently, the backdrop is supportive, providing the right balance between slowing, yet stable growth. Bessemer’s All Equity Model portfolio focuses on areas of the market that have historically been more resilient during periods of slowing growth and has below benchmark exposure to the most cyclically sensitive sectors, such as financials and materials.

Student Loan Payments Set to Resume Following Three Year Pause

What is happening: After several extensions, the more than three-year-long moratorium on federal student loan payments and interest accrual is coming to an end. Interest on student loans will start accruing in September, and payments will resume in October. Federal student loan debt is estimated to be approximately $1.6 trillion, and it accounts for over 90% of total student loans. Based on pre-COVID repayment rates, monthly interest payments are estimated to be around $250 per borrower.

Why it matters: Consumption has underpinned economic growth, but headwinds are building. While consumers could previously redirect savings from delayed loan payments toward other areas of their budgets including discretionary purchases, they will now be faced with tradeoffs. The payment resumption combined with other emerging factors, such as dwindling pandemic savings, is likely to slow consumer spending in the fourth quarter. However, some important mitigating factors lead us to believe that the impacts on economic growth are likely to be modest. With a 12-month grace period, those in forbearance can avoid having unpaid loans marked as delinquent, though interest will still accrue. Additionally, government-supported income-driven repayment plans should help some borrowers. Most notably, the largest proportion of student debt appears to be held by higher income quintiles, who are typically able to better service their debt burdens. These factors, along with a still strong labor market, lead us to believe that the resumption of student loan payments will not be a primary driver of the medium-term trajectory of the economy.