Summary, Last Quarter:
The U.S. consumer, and thus the economy, showed resilience in the third quarter, leading to an uptick in inflation and bucking the downward trend inflation enjoyed for most of this year. That drove the Federal Reserve (the Fed) to raise rates by 0.25% in July and warn that rates will stay higher for longer than originally anticipated in their September meeting. Unemployment—the second pillar of the Fed’s dual mandate alongside inflation—saw an uptick as more workers returned to the workforce. The consumer savings rate declined, disposable income was flat, and the 30-year mortgage reached its highest rate in years. The manufacturing and services components of the Purchasing Manager’s Index (PMI) both increased as well, indicating strong health among American consumers.
Our Commentary:
Although it was an unwelcome surprise, we view the third quarter’s uptick in inflation as a bump in the road and reflective of a strong U.S. consumer, particularly the “Baby Boomer” generation.
Not only have so-called Boomers amassed a remarkable amount of wealth, they are largely in retirement now. When in retirement, people tend to spend their money—whether that be by design, wealth transfers, gifting activity, or simply because of required minimum distributions (RMDs) from their retirement accounts. Many Boomers are also taking advantage of the strong jobs environment and taking part-time employment opportunities to earn income while in retirement. In fact, many employers view Boomers as a preferred source of labor and are actively recruiting them. This leads to an interesting dynamic in which some members of our most-supportive demographic in our consumer-led economy aren’t just spending money, they are making money. This dynamic likely will lead specific geographical areas of the nation, namely retirement areas, to experience growth while other areas either stagnate or decline. The strength of the Boomer demographic is a large reason that the Fed may have to keep interest rates higher for longer. It is also part of what is helping the Fed “thread the needle” so far in this unique post-Covid recovery period.
The stock market declined after two quarters of gains, as investors adjusted their expectations to higher-for-longer interest rates. On the bright side, corporate earnings have been strong and provide the potential for a robust outlook, if all things stay equal. This is a considerable “if,” because the Fed’s continued effort to slow the economy down could lead to lower future earnings, and thus lower stock prices.
Bonds have exhibited an interesting dynamic this year, as shorter-term bonds have provided significantly more return than longer-term bonds. The third quarter was challenging for bonds, however, as bond prices declined while rates increased (bond prices and yields move in opposite directions). The yield curve remains inverted, which means shorter-term bonds are offering more yield than longer-term bonds. This disincentivizes risk taking, which slows down lending and should slow economic growth. This result is exactly what the Fed wants in this inflationary environment, and it has been working so far. Overall, we view the past quarter as indicative of a strong U.S. consumer, but also as somewhat of a bump in the road toward taming inflation.
Until next quarter,
Leelyn Smith Investment Committee
Bond Disclosure:
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