By Patricia Chadwick
In 1980, shortly after being hired at Citicorp Investment Management, Inc. (CIMI was how we referred to ourselves), I was introduced to Bob Davis, a full-blooded Texan, who ran the company’s investment office in Houston. We had important things in common—primarily, our youth (we were both thirty-two at the time) our passion for the world of investing, and our endless drive. Over the ensuing years, we also found ourselves engaged in heated debates over issues that impacted the markets—Federal Reserve policy, market valuation, economic growth and corporate earnings. It was intellectual as well as rewarding to espouse then defend our often highly-divergent opinions. On occasion, one of us might even convert the other, but for the most part, sparring was a useful and enjoyable exercise in mental gymnastics. A couple of weeks ago, Bob sent me a commentary he had just completed, and for the first time in perhaps decades, I agreed with everything he wrote. He inspired me to write this column, one that is optimistic about the investment environment over the next year. Here’s why.
In the first place, let’s look at monetary policy. During COVID, the Federal Reserve (the Fed) aggressively increased the supply of money to offset the disastrous economic effects of the pandemic. The impact was salutary, but it came with a downside. The easy money policy, combined with the COVID-induced global supply-chain disruption, brought a spike in inflation, which prompted the Fed to reverse its earlier policy. Having allowed the money supply to soar, the Fed is now reining it in and by next year, it should be back to its normal growth trend. Additionally, the supply chain bottlenecks are being resolved with the result that commodities prices have come down dramatically. The WTI (West Texas Intermediate) oil price is $70 today, down from a peak of $118 during the last twelve months. Natural gas is around $2.50 today, nearly 75% below its recent peak of $9.38. The price of lumber is currently around $500, versus $670 a year ago. Soybeans have fallen from $1700 to $1327. Copper is $3.70, down from $4.75. The Fed said inflation was “transitory” and it certainly has been in commodities.
Rising interest rates have increased the cost of financing both a home and a car, with the result that consumers are now holding back their purchases. The resultant decline in demand is reducing home prices in most parts of the country, and car prices are starting to crack. The prices of agricultural commodities—wheat, corn, eggs, poultry, etc.—have also declined from their peaks in the summer of 2022. The service sector remains the last area of significant inflation in this country. There is a game of catch-up going on, in my opinion, but let’s not forget the very direct economic tradeoff between capital and labor. If labor becomes too expensive, companies will invest in capital—think MacDonald’s robots. Artificial intelligence is a potent catalyst in the long term trend of replacing labor with capital.
The result is that inflation in the U.S. is down from a peak of over 9% year a year ago to 4% today. While that is above the 2% targeted by the Fed, 2.5%-3% is foreseeable in the near future. The June pause in rate increases by the Fed was a positive response to the more moderate level of inflation, and I would expect the Fed to take its foot off the brake early in 2024, an election year. There is precedent for such activity over a long span of history.
On the economic front, we are likely to witness two to three more quarters of slow growth, with the cyclical interest rate sensitive industries—commodities, energy, retail—absorbing much of the pressure. That said, a recession, as defined by two back-to-back quarters of declining GDP, is unlikely. Furthermore, it’s important to keep in mind that the stock market is a “leading indicator.” It looks forward, and 2024 is just around the corner. So far this year, the S&P500 is up 14%; however, on an equally weighted basis, i.e. excluding the sizable gains in large technology stocks such as Apple, Microsoft, Amazon, and NVIDIA, it has returned only 3.9%. While there may still be some potential for earnings disappointments during the next couple of quarters, the outlook for 2024, now in the market’s sights, is brightening. This should bode well for value and cyclical stocks. I’ll leave you with one final point: since 1928, there have been twenty-four presidential elections in the U.S. In twenty of those election years, the market produced positive returns. Not bad odds, even if you’re not the betting sort.
Patricia Chadwick is a businesswoman and an author. Her recently published memoir, Little Sister, the story of her unusual childhood growing up in a cult, is now available in paperback. She is currently working on her second book, Breaking Glass, about her “growing up” on Wall Street. www.patriciachadwick.com
