GW&K Investment Review 1Q 2024
ECONOMIC COMMENTARY
There seems to be an important and profound difference between how Americans are living their lives and how they’re feeling about the health of the country. With unemployment so low, wages rising, and home/work schedules more flexible than ever, one would expect the nation’s mood to be upbeat, but that is not the case.
The discontent is less about the impending election, which of course is everyone’s concern, and more about the inability of the general public to maintain a consistent standard of living. The inflation of the last few years has become a real issue for many, as their lifestyles are being threatened. For those who own homes and have locked in low borrowing costs, the future is more secure. For those renting, the idea of buying a home at these interest rates seems infeasible, while the prospect of inflation slowing really doesn’t solve the problem since it only means costs will rise more slowly.
This inflationary period has been caused by three factors: the government’s immediate response to COVID, the policies that followed, and increasing barriers to trade around the world. The initial reaction to the outbreak was to expand government deficits to help those most impacted by the pandemic. Simultaneously, the Federal Reserve reduced interest rates to near zero. Both events flooded the country with liquidity. These policies continued, in retrospect, far too long.
To its credit, the Fed understood that inflationary pressures would have a significant effect on the health of our economy and so reversed direction in 2022 and aggressively increased short-term interest rates. Unfortunately, the federal government maintained and even expanded its deficit spending, which was and is counterproductive. The lack of fiscal discipline has put the responsibility for anti-inflationary policies squarely on the back of the monetary authorities. And the prospect of fiscal policy discipline is unlikely no matter who wins the November presidential election.
The third factor also began during the pandemic, when companies were unable to fulfill orders. The business practice of maintaining low inventory for just-in-time deliveries backfired. Post-COVID, these trends were exacerbated by world events. Whether it is the two wars now taking place or a general feeling of mistrust, governments around the globe are reversing their attitude from interdependency to independence. World trade is now being impacted by tariffs and the threat of tariffs. Companies need to expand channels because they can no longer rely on a single supply source. There is a cost to this behavior — higher prices. The deflation that we enjoyed when China was our factory floor is now a thing of the past. The need for secure and trustworthy input sources will increase costs right down the supply chain. World governments are now more protectionist than they have been for years and that is not going to change anytime soon.
The transformation of the world over the last five years has been beyond anyone’s predictions. Reflecting on this period, we need to consider a pandemic that killed millions of people, two hot wars, tariffs, protectionism, inflation, and real political tension, both domestically and internationally. You can be forgiven for thinking stocks would have performed poorly during that stretch. Although we saw plenty of volatility, we also experienced a healthy rise in prices. Part of the underlying strength of US stocks has been management’s ability to adjust to changing times. In addition, our DNA of innovation, creativity, and entrepreneurship has given us the ability to thrive. Just as we found vaccines for COVID, we are also finding high-tech solutions to meet the never-ending desire to create.
As the injection of high interest rates chips away at inflation, it is too early to know whether this will drive the economy into a recession. Whether it does or doesn’t, economic activity will slow and the dissatisfaction among the middle class will increase. Stuck with higher prices, it will be hard for most Americans to feel secure. It seems unlikely that the endgame will be a healthy economy with slowing inflation and reasonably low unemployment. There is no magic bullet since deficits are now so large even in these “good times.” There will be a huge stress on priorities.
Investors need to be patient; there are always investment opportunities. In addition, for the first time in years bonds offer an attractive yield while providing a safe haven. Long-term interest rates will not rise from here now that inflation is abating. How quickly longer rates decline will be determined by the inflation trend. Either way, bonds are attractive. The stock market’s resilience will always be there, so keep your portfolio diversified.
Harold G. Kotler, CFA
Founder-Chairman, Chief Investment Officer