Ketu Desai
By Ketu Desai
Higher for longer.
That is the message that the Fed sent about rates at their meeting this month. Along with higher rates, the Fed expects growth to be more resilient and inflation to be more stubborn. Many market participants expect that the Fed will start cutting rates next year. There are potentially two reasons why the Fed would cut next year. The first is if the economy significantly weakens. The data continues to be strong. Third quarter GDP looks like it will come in well above trend, likely near 3 percent.
Initial jobless claims remain near 50-year lows. The consumers’ balance sheet remains strong. JPM estimates that there is around $1.2 trillion in excess savings. The positive carry they earn from the spread between their mortgage and cash continues to increase as rates move up. There is approximately $2 trillion in fiscal spending in the pipeline, which will start to hit the economy next year. Over the last year or so, companies have been preparing for a recession, in doing so, they have been reducing inventory, while not placing significant new orders. As the recession continues to be pushed out, we will soon hit an inventory restocking cycle, which will further support growth. A more abstract factor is the recent pick up in productivity. Productivity has been annualizing north of 3 percent, which also helps support growth. The second is if inflation comes down faster than expected and real rates become onerous. Inflation will likely be more stubborn as stalling shelter and car prices need to be balanced with energy, wages, food, and goods’ prices. The Fed’s bar for cutting rates will be high and difficult to reach.
TINA (There Is No Alternative) became a popular acronym among investors in the 2010s. With rates near zero and real rates negative for much of the 2010s, there was often no alternative to equities to generate a meaningful return. While there is an alternative to equities now, within equities TINA may be making a comeback for high quality US companies. Europe continues to face a challenging economic outlook. The ECB forecasts sluggish GDP growth of just 1 percent next year with inflation of 3.2 percent. Many economies in Europe are likely to fall into recession, especially if energy prices keep rising.
China is struggling to recover with particular pain in its property sector. China’s largest privately held property developer is on the verge of default. The government has initiated many smaller scale stimulus measures that have yet to have an impact. There appear to be both secular and cyclical headwinds for the Chinese economy. While there are pockets of opportunity in other countries in Asia and Latin America, given the history of these countries, the risk/reward is not favorable for a significant bet. The dollar has continued to rally, which is another headwind. Given the challenges elsewhere, there is no alternative to high quality US companies for global equity investors.
It is not a wholesale opportunity in US markets. Dispersion within equities has made a comeback, with the market picking winners and losers within sectors. Take healthcare for instance, we have seen a massive bifurcation between the companies focused on obesity and everyone else. The obesity related names are up 50 percent for the year, while the broader healthcare index is down. In semis we have seen a similar bifurcation between AI related names and everyone else. In banks it has essentially been JP Morgan versus everyone else. In streaming, it has been Netflix dominating. Caterpillar has diverged from Deere. Walmart has outperformed Target by nearly 50 percent over the last year. FedEx has outperformed UPS by approximately 80 percent in the last year.
Across most industries you can find significant dispersion. When there is more dispersion, positions in broad-based ETFs often net each other out, resulting in disappointing performance. This can be seen in the performance of the equal weight S&P and the Russell 2000, which are essentially flat on the year. The market cap weighted S&P has been held up by large cap tech. As rates remain higher for longer and quantitative tightening continues to drain liquidity, money flows to the best. Investing, in both private and public markets, requires more selectivity than it did when money was free. For more than a decade it has not paid to be a stock picker, we may now be entering a new era in investing.
Looking forward, the markets will focus on the economic data and earnings.
Ketu Desai is the Principal of i-squared Wealth Management Inc. (www.isquaredwealth.com), an investment management firm based in New Jersey. ketu@isquaredwealth.com
