9NOVEMBER 2023eroded purchasing power, and consumers have spent any excess savings accumulated during the pandemic. As a result, retail sales, a major driver of GDP, are declining.The good news is that several significant components of inflation are poised to improve in the second half of this year, thus lowering the odds of a deeper or protracted recession.Core goods inflation will continue to decline, led by used car prices and improving supply chains. The shelter component of CPI will likely fall despite an increase in home prices because the cost of renting is trending lower. What we are watching The Fed is keenly focused on the labor market, particularly the overhang of excess demand for labor, which it sees as a major source of wage inflation. While there are signs that inflation, in general, is cooling, the service side of the economy is still struggling with labor costs. The Fed is concerned that backing off rate hikes now and leaving the labor market in its current imbalance will not fully subdue inflation.Each rate hike increases the odds of a recession but, at the same time, ensures that inflation continues to fall toward the long-term target of 2.5 percent.If the economy falls into a shallow recession beginning in the fourth quarter of 2023, it won't be much of a surprise. Conversely, with so much anticipation, it is equally plausible that consumers and businesses will adjust spending and output preemptively, thereby avoiding an actual economic contraction. Much depends on the Fed not overshooting their target.Investment ConsiderationsA severe economic downturn is becoming less likely, which is certainly a positive. The flip side, though, is we may have sluggish economic growth for the foreseeable future. In that environment, generating solid returns is more challenging. It will become especially important to watch costs while also making solid investment decisions. Part of our focus on the investment side includes:· Fixed income. Consistent returns are desirable in such an environment. · Dividend-yielding investments often are sound since they supply current income.· Active management within high-quality companies with strong earning potential and companies with strong innovation (such as Generative Artificial Intelligence) are appealing.Part of our focus on the expense side includes: · Being prudent on the number of transactions. Changing investment positions often come with transaction fees.· Making sound decisions to minimize taxes is important, particularly in this scenario. · Exposure to low-cost funds and trading on lower volume days often reduce expenses. A severe economic downturn is becoming less likely, which is certainly a positive. The flip side, though, is we may have sluggish economic growth for the foreseeable future
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