4Q23 Mid-Quarter Update

The Resilient U.S. Consumer and Labor Markets

John P. Swift, CFA, CPA Chief Investment Officer
312-259-9595 or jswift@trustbenchmark.com

Summary

• Our October 2nd Market Outlook indicated that “with an oversold bond market, an overbought oil market, and expectations of record earnings, investors can still make a strong Bull Case for the market going forward.” That call has worked out well so far.
• The October CPI report tomorrow will be encouraging.
• Household balance sheets remain strong and improving, which refutes the popular narrative of a consumer under siege.
• The labor markets will remain strong for several years to come.

Revisiting October 2nd Market Outlook

In our 4th quarter “Market Outlook,” we indicated that “with an oversold bond market, an overbought oil market, and expectations of record earnings, investors can still make a strong Bull Case for the market going forward.” That certainly was not the prevailing narrative then. The gloomy outlook by most prognosticators today has moved on from worrying about the bond and energy markets that have both improved to worrying about wars, inflation, the Fed, and the resumption of federal student loan payments (Horrors! We need to repay these things!?), and higher credit costs.
 
They were wrong then, and they’re wrong now.

Since our last note, the S&P 500 has gone from 4,284 on October 2nd to 4,416 today, for a solid price return of 3.1% over the past month and a half. So far, so good.

 October CPI Report

The October jobs report was so good that it provided another piece of evidence supporting our position that a soft landing is transpiring. The job report is moderating at a pace that doesn’t yet indicate a recession. Wage pressures are easing, helping the Fed in its quest for a 2% inflation rate, and productivity continues to be positive.

Many in the Wall Street consensus now think that the inflation number will show dogged persistence in the face of tightening and that the Fed’s job will be hard. To be sure, they have some compelling evidence in their corner. However, we’re primely positioned for a downside upset of consensus expectations.

We may see some real weakness as some supply-side drivers continue the normalization process, and a steep monthly drop in energy prices should be prominent in the report. And despite the strength in rents that helped the report exceed expectations last month, independent measures continue to suggest price pressure is forthcoming. Furthermore, some compelling research from the San Francisco Fed suggests that shelter inflation will be coming down convincingly in 2024.

If you remove shelter from the core CPI, it drops to well below 2% and brings broader CPI to 2%. If this report shows the first cracks in shelter costs when Energy has fallen so quickly, a significant downside move in CPI is possible. The following CPI report is coming out on Tuesday, November 14th. Wall Street highly anticipates this report because one of the critical things market observers are looking for is evidence that the Fed has vanquished inflation. This CPI report will show encouraging progress towards the Fed’s 2% objective.

Drop in Oil Prices Helps Curb Inflation

In the 14 other months since 2005 that saw gas prices decline -9%+, headline CPI during the comparable month dropped an average of -0.4% with negative readings 12 times.

This factor suggests that CPI forecasts are too high. Seasonality for gasoline would likely be a positive factor in the last two months of the year. That dynamic is playing out nicely so far, which is particularly impressive given the white-hot tensions in the Middle East. However, I have been confident since the October 7th attacks that despite the shocking nature of this chapter of the Arab-Israeli conflict, the effects on markets and volatility would be much more subdued than consensus expected.

Furthermore, an underappreciated factor that should be showing up in the inflation numbers is that the world’s second-largest economy has been experiencing severe weakness. China is experiencing outright deflation right now, and that weakness will certainly mean lower prices for many U.S. consumers. The Fed has surely noticed such a significant development

Strong Household Balance Sheets

We have written on the soundness of the U.S. consumer balance sheet many times over the past year and a half, and the solid foundation has only improved. Below is the graph of Household Debt Service Payments as a Percent of Disposable Personal Income; not only has this metric remained at 45-year lows, it shows continued improvement during 2023. 

This fact argues against those who warn of higher credit costs as an essential concern about a coming recession. This concern is unfounded and not supported by the data indicating that the U.S. consumer is not only on solid footing but continues to improve their financial stability due to a strong labor market and real wage growth.

Continued Strength in Labor Markets

We see continued strength in labor markets that will last for years to come based on the following:

1. Baby Boomer Retirement & Heavy Initial Retirement Spending – As we have written, Baby Boomers are retiring in droves. Still, they remain relatively young and are in the initial stages of retirement, which features heavy spending on travel and other personal pursuits. This creates an end demand for goods and services that need to be provided by a smaller workforce population of Generation X, Millennials, and Generation Z workers.
2. Growth of the working-age population is at its lowest since the Civil War. We need to match the end demand and the labor supply available to meet this demand. The result is continued lower unemployment rates and labor price inflation remaining a concern towards achieving the Fed’s inflation mandate.
3. Immigration is not meeting expectations. Our relatively closed-door immigration policies have slowed population growth from immigration, and a resumption of opening our borders has not improved that trend materially.
4. Worker productivity has improved dramatically, not due to new artificial intelligence tools. The AI movement is in its initial rollout and will be a source of continued worker productivity in the future. However, today’s productivity gains are primarily due to higher worker satisfaction. During the Pandemic, we experienced a reshuffling of workers, which many called the “Great Resignation.” Workers, who were and remain in high demand, could leave their jobs in droves and seek out their preferred careers and positions. Many found these jobs to the point that worker satisfaction has improved markedly, and a happy worker is productive.