Weekly Investment Update (09/22/2023)

This Week’s Views and Positioning

Although better-than-expected initial unemployment claims (+201k versus estimates of +225k) keep hope alive for a “soft landing,” the jobs report also raises concerns about a more prolonged period of restrictive monetary policy. Stronger-than-expected labor market data reinforced investor sentiment following the Federal Reserve meeting, in which Fed officials reduced expectations of rate cuts in 2024 from 100 basis points (bps) to 50bps. A realization that policy rates may need to be “higher for longer” given the current strength of the economy put renewed pressure on equity markets. As we have highlighted in recent publications, good news for the economy is likely bad news for stocks.

Our view continues to be that evidence of slowing economic growth will emerge as we approach year end. Along with the natural slowing of growth associated with restrictive policy, the United Auto Worker (UAW) strike, a possible government shutdown, and the resumption of student loan repayments may further weigh on economic activity. Signs of a downshift in economic growth would, again paradoxically, likely provide near-term support for stocks. As such, we maintain our overweight to equities while also staying underweight certain sectors and regions that are more sensitive to an economic slowdown.

The Federal Reserve Delivers a Hawkish Pause

What happened: While the Federal Reserve left interest rates unchanged this week, the year-end median 2023 dot plot continues to include an additional 25bp hike this year. Meanwhile, the year-end rate projection for 2024 showed only 50bps of interest rate cuts versus the 100bps expected prior to the meeting. Relative to its June projections, the Fed now expects lower unemployment and faster economic growth through year end. The Fed reiterated that inflation remains elevated, with its projections including a very small upward revision to inflation for this year.

Why it matters: The Fed signaled that to restore inflation back to target, policy rates will need to remain restrictive for longer than previously anticipated. As equity investors factor “higher for longer” into their expectations for a soft landing, valuations have come under pressure. Going forward, the length, not the height, of the fed funds rate ceiling will be the critical variable. We believe economic data in the coming months will support the end of the rate hike cycle, but the Fed will continue to guard against backing off too soon. In our view, the Fed’s primary objective at this time is price stability. In order to achieve that objective, economic growth will likely need to remain below trend for some time or unemployment would need to rise materially before rate cuts are considered. For this reason, we continue to expect some reduction in earnings expectations for 2024. As a result, Bessemer continues to favor quality growth companies that we believe can maintain relatively stable earnings growth in such an environment. Although the Fed’s overnight policy rate may remain at or near current levels, Bessemer bond portfolios have been adjusted so duration is above that of the benchmark, given our belief that the Fed is either already finished, or close to concluding, its hiking cycle. (Portfolio duration is the portfolio’s price sensitivity to a change in market yields.)

United Auto Worker Strike Enters Its Second Week

What is happening: Every four years, the United Auto Workers (UAW) union negotiates new contracts on behalf of its 146,000 members working at Detroit’s three largest car makers: Ford, General Motors, and Stellantis (Chrysler, Jeep, Ram). The car makers and UAW have been at odds over the new contract, and last Friday, with no agreement having been reached after months of negotiating, the union decided to strike at plants operated by each of the largest manufacturers. It is the first time the UAW has simultaneously gone on strike against the three largest auto makers. The UAW’s demands include a 32-hour working week, at least a 40% wage increase over four years, a return of a defined benefit pension, and a reinstatement of a cost-of-living allowance tied to inflation. The demands are part of a wider tactic to help protect its workers as the automotive industry transitions to electric vehicles (EVs), something the union has estimated could eventually cost up to 35,000 jobs.

Why it matters: Although the strikes have so far not been terribly disruptive to auto production, the UAW has warned that more facilities could go on strike in the coming weeks unless there is “serious progress” in talks. The automotive industry contributes approximately 3% of U.S. gross domestic product (GDP). Should the strikes expand and continue, there would likely be ripple effects to other parts of the economy, for example, to steelmakers, who might be forced to idle production. Any extended disruptions to the supply of vehicles would lead to downward pressures on economic growth and upward pressures on prices at a time when the Federal Reserve is trying to delicately engineer a “soft landing.” It is difficult to quantify the short-term economic impact of the strikes as it will depend on the size and duration of the actions, but ultimately the costs to the economy should be marginal if a resolution is reached over the coming weeks.