Q4: Navigating Late-Cycle Investing

by | Oct 4, 2023 | Market Updates

Investors find themselves faced with a dilemma. On the one hand, they are relieved that the government shutdown has been avoided. On the other hand, they remain concerned about high interest rates. However, amidst these worries, there are reasons for optimism. September, typically known as a tough month for stock market investors, lived up to its reputation. Despite this, we are now witnessing positive signs.

The stock market experienced a challenging September, with the S&P 500 dropping by 4.87% and the Dow Jones Industrial Average falling by 3.50%. However, the stock market started to rebound in July, moving away from concerns of a recession and towards a more favorable scenario for the U.S. economy. While a deep recession is not expected, it is important to focus on the resilience of equity portfolios in our current late-cycle investment environment.

As for interest rates, the Federal Reserve decided to keep rates steady at a 22-year high. However, there is still a divide on whether the Fed will raise rates again. Despite this uncertainty, the market is showing signs of strength and favorable conditions for stock pickers, with a broader market dominance emerging. The Fed is reaching a critical point in its battle against inflation, and the next couple of months may determine whether or not it can navigate a so-called soft landing for the U.S. economy without tipping it into a recession. We maintain a careful balance between stocks and bonds as the U.S. Treasury yield curve remains inverted (since mid-2022), a historically strong recession indicator.

In fact, the New York Fed’s recession model predicts a 60.8% chance of a U.S. recession sometime in the next 12 months.

It is not easy for an investor to gauge or feel the effects of the economy during the course of daily living, as evidenced by surging home prices and consumer spending surged over the summer.

As mentioned above, we have seen home prices increase dramatically due to a structural mismatch between supply and demand. Supply has not recovered from years of underbuilding, while demand has skyrocketed thanks to the Millennial generation. High mortgage rates have caused existing homeowners to hold onto their low rates, further limiting supply. High rates also hinder affordability, especially given high home rates, which translates into a lower number of qualified buyers. Affordability is now at its worst levels since the 1980s, with the average worker needing a significant portion of their wages to cover mortgage payments for the median existing home. Saving for down payments has become increasingly difficult, given these high prices.

MorningConsult Pro states that spending in discretionary services has boosted top-line spending growth this summer, primarily driven by Millennials and Gen Zers. However, as young consumers face increasing budgetary pressures this fall—such as resuming student loan payments and rising credit card interest rates—the positive momentum of discretionary services spending, gained over the summer, may be at risk. The engine behind the U.S. economy is consumer spending, and we will continue to watch it closely.

Economies move in cycles, and each cycle brings its own challenges and opportunities. In many aspects, the current cycle has shown signs of aging and we are likely in the late cycle. As investors debate the chances of growth or recession, we think the overall journey merits its own consideration. Staying on the sidelines could prove costly, which is why we believe an active, diversified approach will continue to deliver steady returns regardless of the economic backdrop.

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