Weekly Investment Update (09/08/2023)

This Week’s Views and Positioning

Equity market sentiment hinges on the notion that the Federal Reserve has completed its rate hiking cycle. In fact, the bond market continues to price in rate cuts throughout the course of 2024. In part, this narrative has helped boost valuation multiples, which have been the primary driver of stock returns year-to-date. Below, we discuss both the labor market and energy prices, primarily due to their impact on inflation and subsequent monetary policy.

As highlighted in recent publications, equity investors are looking for additional signs of slowing growth to assuage fears of persistently high inflation — in other words, “bad news is good news.” In our view, equity investors will get their wish, and economic growth will continue to slow. This will likely begin to manifest in additional labor market weakness in the coming months. Given that the average historical lag between the trough in the fed funds rate and the trough in the unemployment rate is 23 months, additional increases in the unemployment rate could be seen sometime in the first quarter of 2024. Paradoxically, signs of further economic weakness should initially be supportive of stocks, supporting our continued overweight to the asset class. We continue to see the odds of a severe recession, in which bad news would be bad news, as relatively low.

Labor Market Remains Healthy With Labor Supply Increasing

What is happening: Labor demand has continued to cool from the elevated levels seen last year but is still healthy with nonfarm payrolls rising 187,000 in August, surpassing the consensus estimate of 170,000. Moreover, around 64% of industries in the private sector reported increases in employment in August, up from around 57% in July. Although the unemployment rate rose from 3.5% to 3.8%, the increase was primarily a result of a higher labor force participation in August. Most of the gain in the labor force this year has been through the prime-working age group, 25-54 years, with a particularly strong gain in the female workforce. As a result of continued labor supply and demand rebalancing, year-over-year average hourly earnings eased to 4.3% in August after rising 4.4% in July.

Why it matters: The report likely provides the Federal Reserve with enough evidence to leave rates unchanged in September. For equities to continue to rise, we believe that the economy must strike the balance of slowing enough to give investors confidence that monetary policy is sufficiently tight but not so much that it damages market sentiment. While a continued increase in labor supply would be well received, we believe that the recent pickup in participation rates cannot be sustained at its current pace. Prime-age labor force participation has rebounded since the initial COVID lockdowns and has now notably returned to its pre-pandemic levels given increased immigration and fewer workers citing COVID as a reason to stay out of the workforce. Bessemer’s All Equity Model Portfolio is underweight more cyclically exposed sectors of the market as we expect the Federal Reserve to attempt to meet its inflation mandate and, in turn, slow the pace of economic growth by keeping rates at high levels.

Rising Oil Prices Have the Potential to Impact the Consumer and Inflation

What is happening: Brent crude oil prices rose above $90 per barrel for the first time since November 2022 as key OPEC+ members look to maintain production curbs in an effort to support higher oil prices. With both Saudi Arabia and Russia announcing extensions to their production cuts through the end of the year, the oil market is poised to see the highest level of cuts in the last 20 years (outside of recessions). Meanwhile, global oil demand appears set to breach record levels, especially as China’s ongoing reopening contributes to oil demand growth. We note that China accounts for more than half of global oil demand.

Why it matters: Changes in crude oil prices have a passthrough effect on gasoline and petrol prices with implications for both the consumer and inflation. Higher gasoline prices can have a negative effect on consumer sentiment as they can force adjustments to consumer spending patterns. Beyond their impact on gasoline prices, higher oil prices can also have second-order effects in other categories. For example, airline ticket prices often rise alongside increases in jet fuel costs. To the extent the effects of higher oil prices appear in inflation data in the coming months, the Fed would likely be faced with additional pressure to maintain its higher-for-longer stance.

Bessemer portfolios increased exposure to energy and commodity-related companies in 2022 and have maintained energy exposure that is roughly in line with the benchmark weight this year. Structural supply issues, the ongoing war in Ukraine, and OPEC+ production cuts, combined with demand growth as China more fully reopens, are likely to contribute to an environment that is supportive of commodity prices, underscoring our rationale to maintain portfolio exposure at this time.