The economy roared ahead in the third quarter of 2023. The Atlanta Fed GDPNow predicts that Gross Domestic Product grew 4.9 percent in that quarter. Given several meaningful headwinds, I suspect that GDP in the current quarter will be more subdued.
Governing challenges for Congress
On September 31, 2023, Congress avoided an economic mess, at least for now. Capitol Hill kicked the can down the road that day when lawmakers extended government funding through mid-November. Whether Congress fixes the problem, shuts down the government, or kicks it down the road down again, the uncertainty about the economic fallout will surely be more of a negative than a positive.
United Auto Workers strike
The UAW strike has been targeted in its focus since it began on September 15, 2023. It is broadening out to more of the “Big Three” automaker factories (General Motors, Ford, and Stellantis). I had earlier projected the strike to last about 59 days, getting us to mid-November. At that point, the lot inventory would get tight. If the strike lasts only through the rest of October, it will still reduce GDP growth in the fourth quarter by about 0.3 percentage points. That includes lost income beyond that of the Big Three and their employees. Parts manufacturers and auto dealerships will also miss out on sales. Also, downstream businesses that would have otherwise sold more to striking UAW workers will miss out, too.
Student loan payment resumption
After three years of suspended payments, the U.S. Department of Education’s COVID-19 relief for student loans ended last month. The first payments were due on October 1, 2023. Twenty-four million Americans will resume average monthly payments of $300. That is an annual total of about $86 billion. Many of these borrowers are in an economic demographic with a marginal propensity to spend that extra $86 billion. The resumption of loan payments will weigh on economic growth to the tune of another 0.3 percentage points of GDP this quarter.
The increasing cost of oil
The cost of a barrel of oil is up considerably from a few months ago. If oil stays roughly at current prices for the fourth quarter, it will be up about $10 per barrel more than in the third. In the long term, that doesn’t have a meaningful impact on the U.S. economy because America produces about as much oil as it consumes. However, it is a negative for American households and businesses in the short term.
Inflation will be pushed up because of higher gasoline prices, directly hitting household incomes. Gasoline and petroleum costs also filter into the cost of manufacturing and transporting goods, pushing prices of finished products higher. Inflation expectations then increase, pushing up wage growth and bullying the Federal Reserve to maintain its higher-for-longer stance on interest rates. Higher oil prices will be about a 0.25 percentage point drag on GDP this quarter.
Long-term yields surging
Yields of 10-year Treasury Notes averaged about 4 percent in the third quarter of 2023. On October 2, 2023, Notes hit 4.7 percent, their highest since August 2007. This affects households who find it more expensive to purchase a home. Higher long-term rates prevent corporations from hiring, investing, and expanding. It is worth noting that before the 2009 Great Financial Crisis, it was not uncommon for the 10-year Note to yield around 4.5 percent. Still, consumers need time to adjust to the new normal (which is really just the old normal). Higher rates will reduce GDP by another 0.2 percentage points this quarter.
More on the effect of surging long-term yields on corporations
On September 27, 2023, Duke University, in partnership with the Richmond and Atlanta Federal Reserve, published the latest quarterly Chief Financial Officer Survey.
Inflation and the worker shortage remain obstacles number three and number two, respectively, for larger companies. However, there is a new number one. “Monetary policy appears to be further dampening business spending and hiring plans,” says John Graham, a finance professor at Duke University’s Fuqua School of Business and director of the Duke survey. When Mr. Graham refers to “monetary policy,” he is referencing higher interest rates, which translates to a higher cost of capital for companies. Over 40 percent of companies reported that interest rates at current levels have resulted in them reducing spending.
What will the stock market do in the last quarter of 2024?
The day after the Duke University study, Bespoke released the findings of a “Year Like” data pull. Years that started like 2023 have historically finished better than all other years.
Returns for the rest of the year averaged 6.1 percent, compared to 3.8 percent for all other years. That is good news for investors chasing gains. That may not hold true for the health-care sector, which I am considering reducing in my portfolios.
The health-care sector has outperformed the S&P 500 over the last two months. That is not unusual. In the previous two decades, health care has outperformed the S&P 500 by 0.1 percentage points over any given 50-day period. Over the last couple of months, health care has outperformed by about four percentage points, which is a statistically significant one-standard deviation move. Rarely does the outperformance of the health-care sector extend its rally to two standard deviations. If I am wrong and health care continues its outperformance, it likely would have to occur during a scenario requiring the broader market to perform. A shift from health care to a broader allocation seems prudent.
Health-care stocks aside, a historical return of 6.1 percent for the broader S&P 500 stock market index is attractive. However, if you are a conservative-ish investor like me, you might also consider the possibility of a loss. In years like 2023, the maximum average loss throughout the rest of the year was -2.7 percent. That compares to an average of -4.5 percent for all years. Soon, much of the rest of the year will be filled with third-quarter 2023 earnings reports for public corporations. GDP ripped ahead of expectations last quarter, so I suspect profits will also come in ahead of current projections.
For those technical reasons, combined with peak inflation and an expected resolution to the government shutdown and the UAW strike, I suspect I will make some changes to my investment portfolios to get more in line with a possible rally in the equity markets for the remainder of the year. If I do, I will let you know.
This reallocation may turn out to be a trade that lasts a few months or a year. The odds of a recession beginning by early 2025 are high. I have not lost sight of the risks.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
