Will Resilience Continue Through 2025?
By Vaughn Woods, CFP, MBA
To slow inflation, the Federal Reserve Board is now threatening to raise interest rates again in November. Inflation is slowing…slowly. Economic resilience is surprising. S&P 500 company earnings have held up. More is expected for 2024. So, the Fed’s actions appear to have limited immediate power. The effects of higher mortgage rates are largely delayed for millions of homeowners who refinanced at 4% or lower. Moreover, corporate interest expenses today are lower than a year ago after refinancing debt issuance when rates were at record lows. And that is just the beginning of a world in which corporate margins are holding up even as inflation cools.
Productivity and Margin Expansion
Today executives are using cloud computing analytics, big data analytics, blockchain supply chain management and artificial intelligence for developing greater efficiency strategies. A study by IBM found that businesses that use blockchain for supply chain management can achieve a 5% to 10% reduction in costs. A study by McKinsey found that big data analytics can increase profits by up to 60%. A study by Salesforce found that cloud computing can reduce IT costs by up to 25%. A study by Gartner found that software as a service (SaaS) can reduce IT costs by up to 30%. And a study by PwC found that AI can increase profits by up to 38%.
The Speed of Uptake
The uptake of these new technology tools is greater and faster among American businesses than elsewhere. This is a major competitive advantage. The adoption of artificial intelligence in combination with the use of neuromorphic computer chips is raising worker productivity. The new chips have the capacity to pass information on within the chip thereby acting like a system of neurons and synapses, much like the human brain.
By combining artificial intelligence with neuromorphic chips designs, the rate of innovation is accelerating. Real time language translation, automated machine learning and manufacturing, improved medical diagnosis, and quality controls are lowering costs and improving corporate profit margins.
Growth and Inflation: Which One Is the Sub Trend?
Over the last three years, the Fed has raised interest rates sharply to lower the disposable income of consumers. Remember, mortgage rates are up 136% since March of 2020. That is, from 3.29% for a 30-year fixed in 2020 to 7.75% today. However, the consumer is showing resilience because most homeowners locked in rates lower than 4% during the low-rate period.
Meanwhile, corporations had access to lower rates and did the same. To illustrate, large corporations had access to the bond market during the period around March of 2020 when the fed funds rate was 0% to 0.25% and locked in very low future funding needs which today is the reason corporate America is paying lower interest payments to debt than in the past.
Now this will change, but it’s going to take a long time with so many mortgage holders and corporate debt holders having locked in safety from the Fed’s activity. So, there is a growing sense that a recession is coming but not until the multi-year fiscal stimulus effects run out. For this reason, some analysts are talking about surprising economic resilience and surprising corporate earnings upside. This means that marginal progress may be coming even as disinflation progress ensues. Such a world, it is thought, benefits the patient investor and Fed credibility.
So, in this scenario Inflation cools; a sub-trend with growth. To put a timeline on this some Federal watchers are estimating that it could take until 2026 for the Fed to achieve its 2% target for inflation. It is thereafter that the large government spending programs passed by Congress since 2020 will largely have passed through the economy.
Fiscal Stimulus Bills and Delayed Spending Over Years
There are several congressional spending bills that have been passed over the last three years. Much, if not most, of this money has yet to make its way into the economy. The delay of fiscal spending keeps inflation buoyant and recession at bay. For example, according to the Congressional Budget Office (CBO) the Bipartisan Safer Communities Act (H.R. 7910) will continue being spent through 2026. A much larger bill, the American Rescue Plan Act (ARPA), which authorized $1.9 trillion to be spent, was to go to state, local, and tribal governments. Since these governments have until the end of 2024 to spend or obligate their funds, it is likely that a significant portion of this remaining funding has been allocated but not yet spent. Before accounting for the spending provisions of the Inflation Reduction Act, according to the U.S. Government Accountability Office (GAO), some 10% of the $4.5 trillion Cares Act of 2020, or $200 billion, has yet to be spent. It is important to note that this breakdown is based on the best available information, but it is possible that the actual figures may vary slightly.
Summary
In summary, unless some black-swan event occurs to shake the U.S. economy to its core, the government’s spending programs should more than help to offset the slowdown in economic growth that is likely to result from the Fed’s interest-rate hikes. A delayed pass-through of higher interest rates means that the economy will likely continue to grow for some time, even as the Fed tightens monetary policy.
As a caveat, it is important to note that there is some debate among economists about the potential impact of the Fed’s tight monetary policy and the government’s multi-year spending programs on the economy. Some economists believe that the Fed’s interest-rate hikes could lead to a recession, while others believe that the economy will be able to avoid a recession. Only time will tell what the ultimate impact will be.
Meanwhile, expect, as is usual, 5%, 10%, and possibly 15% market corrections from time to time as valuation corrections are the way the market checks occur from over enthusiasm or undervaluation waves.
Sincerely,
Vaughn L. Woods, CFP, MBA
Vaughn Woods Financial Group, Inc.
2226 Avenida De La Playa
La Jolla, CA 92037
858-454-6900
Investors should be aware that there are risks inherent in all investments such as fluctuations in investment principal. Past performance is not a guarantee of future results. Asset allocation cannot assure a profit nor protect against loss. Although the information has been gathered from sources believed to be reliable, it cannot be guaranteed. Views expressed in this newsletter are those of Vaughn Woods and Vaughn Woods Financial Group and may not reflect the views of Bolton Global Capital or Bolton Global Asset Management. The information provided is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. VW1/VWA0291.