Better Than Expected

October 2023

The economy has been stronger for longer than anyone expected. It’s been a year at least since the calls for recession began.

No one is really sure why. Oil is rising like demand is strengthening a little. Housing prices are stabilizing. The number of payrolls goes up each month. Commercial real estate is still weak.

I would point to charts that have been reliable indicators in the past, like rising loan delinquencies, personal balance sheets having no more Covid stimulus cash and are now relying on increasing credit card balances. It just hasn’t shown up yet.

Maybe it will, maybe it won’t. The sharp increase in interest rates I would think has got to show up soon. It affects so much - what investors do with cash, how businesses borrow (see table), how governments pay for borrowing - you’d think we’d have felt it more acutely by now.

But stock investors, for their ability to see 6 months out, are not pressing the panic button at all.

That last point, about government borrowing, I think might be the one that drags us down. Most of our government borrowing has taken place in the last 10 years at low rates, like 1-3%. As those bonds mature, the government has to sell new bonds at today’s much higher rates. And then as the government runs a budget deficit, it takes on more borrowing - at higher rates.

That higher interest expense gets to be material. Some forecasts say the government will spend as much on just interest payments as it does on annual defense spending. Unfortunately, that higher interest expense means next year’s budget is likely to have a large deficit too, which means more borrowing.

This self-fulfilling, pessimistic argument has been known forever, not just in 2023 but in past rising rate and deficit environments. We’ll get through it - like every time in the past - but it will make for a new round of uncomfortable national conversations about spending, taxing, etc., which can lead to more cautious investor sentiment.

We’ve had the usual late September/mid October weakness. While I’m concerned about the cost of borrowing and its effect on consumers, businesses and the government, It’s about the time when we start feeling optimistic about next year’s prospects. I wouldn’t be surprised at all to see stocks have a seasonally up return between now and the end of January.

Sincerely,

Chip