Q4 2023 Economic Outlook

Introduction

Americans are spread thin and the Federal Reserve’s ‘higher for longer’ interest rate policy could push the economy to the edge. Whether we fall over or not is yet to be seen, but we are contending with numerous restrictive forces including:

• Rampant money printing and corporate profits leading to sticky inflation, and the resulting ‘higher for longer’ interest rate policy

• Households becoming over-extended and running out of savings

• The housing market becoming stagnated with the lowest mortgage applications since 1995 as mortgage rates surge to the highest levels since 2000.

• Student loan payments resuming at a time when most people are living paycheck to paycheck

• Teachers, nurses, and most recently, auto workers are striking for better pay to weather the sky-rocketing cost of living, but may inadvertently cause higher inflation

As we kick off the final quarter of the year, I’ll examine the state of the housing market, economic forces affecting various industry sectors, and the risks and opportunities on the horizon.

Housing market activity slumps, prices remain steady for now

Nationally, housing market activity has slowed with active listings down 18.6% Y/Y to 1.5M, and prices seem to be consolidating after rising steadily all year.

The median sale price stands at $420k, up 3% Y/Y with low inventory accounting for much of the rise.

Nationally, there are only 2 months of supply, continuing a steady downward trend indicating a seller’s market even at today’s interest rates (which are over 4% higher than two years ago).

Compared to the summers of 2021 and 2022, where it was not uncommon for homes to sell for 50 - 60% above list price, this June, homes sold above list price peaked at 40% nationwide. Note that this is still well above typical pre-pandemic levels of 20 - 25%.

The decline in home sales may be indicative of a potential recession, though it’s important to note that this has not had a prolonged negative effect on the housing market in the past. Unfortunately for buyers, a recession doesn’t necessarily mean a drop in housing prices. As you can see in the chart, home sales dip leading into a recession, but recover soon afterwards.

Overall, housing affordability is still terrible. In fact, it’s the most unaffordable market since since 1984. During hard economic times, housing and transportation are usually the last sectors to contract since they are necessities. Conversely, luxury goods are usually the first to see price declines and luxury homes are already seeing steep price cuts.

U.S. equities valuations expand as market breadth weakens

U.S. equities may experience increased volatility into the end of the year as investors weigh fears of a new recession against the possibility of interest rate cuts and liquidity injections to deal with said recession.

“At the current juncture, it is difficult to be overly bullish in equities. While performance this year has been better, it has been entirely driven by valuation expansion on the back of lower interest rate expectations, with the top 10 companies in the S&P 500 accounting for 13.8 percentage points of the 14.9% price return year-to-date. Expectations for policy easing may also be too optimistic and as expectations adjust, multiples could come under further pressure.” (J.P. Morgan) 

ETF Sector Analysis

Technology: The technology sector has generated phenomenal returns this year with $QQQ ETF returning over 33% largely driven by advances in the AI industry. Given the rapid rise and current resistance near the November 2021 highs, I expect some volatility and consolidation until we get clarity on where the Fed will take interest rates. A pull-back to the 50-week moving average could be an opportunity to scoop up tech companies at a more reasonable valuation.

Financials: The financial sector as measured by the $XLF ETF has fared relatively poorly this year, losing investors 3.7% since the first trading week of the year. Investors are likely anticipating potential rate cuts hurting bank profits. The ETF recently failed to breakout from the yellow downtrend line from last year’s high.

Energy: The energy sector returned 3.2% so far this year as measured by the $XLE ETF, though it wasn’t the highest returning sector, the ascending triangle structure could break to the upside if energy demand increases. Fundamental demand for energy must continue to grow in order to power the sector higher, which could be challenging given a projected rise in non-OPEC production, in addition to Russia's need to boost supply to increase revenue.

"If energy prices increase and stay high, that'll have an effect on spending, and it may have an effect on consumer expectations for inflation, things like that. That's just things that we have to monitor,” - U.S. Federal Reserve chair Jerome Powell.

Real Estate: The Real Estate ETF $XLRE has continued its downward march since early 2022 and is testing its lows from October 2022. Sell volume has picked up and relative strength is breaking down, signaling potentially further downside ahead.

Bitcoin: Bitcoin has provided strong returns this year, up 63% since its lows in January. Investors are looking for interest rate cuts, the halving in Q2 2024, and a potential Bitcoin spot ETF approval as a bull market catalyst. Seven major investment firms (Blackrock and Invesco among them) have applied for the license to run a spot Bitcoin ETF but the SEC has delayed the decision multiple times. The next set of deadlines is in mid-January but the SEC must make a decision by mid-March at the very latest.

I recently cut my crypto exposure when Bitcoin rejected below the 29k level, though I do believe the worst of the crypto bear market is behind us and there is reason for optimism if Bitcoin holds above its 50-week moving average.

Labor market is strong for now, but is it 'the calm before the storm’?

“Diminished legal immigration, particularly over the course of the pandemic, and baby-boomers reaching retirement age have left the economy very short of workers. As such, the unemployment rate may only nudge slightly higher in the year ahead despite businesses reeling back hiring efforts in the face of slower demand and higher costs.” (J.P. Morgan)

Unemployment remains at one of the lowest points in history at just 3.8% as of August, but as you can see in the chart below, it’s always lowest before it spikes during a recession.

A curve-ball for the Fed’s inflation estimates will be how the economy responds to the United Auto Workers strike, which will curb auto-production and potentially increase the price of new and used cars currently on the market.

Conclusion

Given the current economic uncertainty and the S&P500’s market leaders starting to pull back, I’m limiting my equity exposure going into the end of the year. I’m looking to begin re-purchasing shares of $SPY at the 50-week moving average (green line in chart below) or if we close back above $450.

Aside from the obvious downsides, a potential recession and ensuing rate cuts and liquidity injections could boost risk-on asset returns after near-term volatility. As investors, we should see a recession and stock market decline as an opportunity to buy assets at a discounted price for long-term investment. As human beings, we should help each other weather the economic storm through mutual support and community-building.

Thanks for reading, and good luck out there.