5C Capital Markets Update

Today’s top news stories may very well leave you with a sense of discomfort, heightened concern or far worse.  Geopolitical pressures and horrific loss of life on multiple fronts call into question the ability of governments to protect their citizens, regardless of political and social structure.  Our hearts break for the victims of senseless killings and the prospect that this will continue unabated for the foreseeable future.  Query whether violence will play a major role in China’s long-stated goal of reunification with Taiwan.

The US economy continues to endure the effect of the Federal Reserve’s seismic shift from Covid-era fiscal and monetary stimulus to the current inflation fighting surge in interest rates.  Fighting inflation via increased interest rates is a time-tested (albeit with mixed success) technique used by governments around the world.  As a practical matter, this means that interest rates for many loans have increased by 5% or greater in the near term.  For many borrowers, costs have become untenable.  Whether a home buyer seeking a mortgage or a corporation/municipality refinancing maturing debt, paying 2X or greater service costs (from 18 months – two years ago) has proved problematic.  These effects have been mitigated by homeowners holding current low-rate mortgages and corporate/municipal borrowers relying on longer termed debt issued at much lower rates.  The theory that inflation will moderate down to the Fed’s target with no economic consequences seems overly optimistic.  Markets may be pricing in cuts to the policy rate in mid-2024. However, we believe the Fed would rather keep rates higher for longer to make sure inflation is truly controlled.  We believe that interest rates are near or at their peak levels.

Our fiscal policy outlook is summed simply: Debt.  Regardless of power dynamic, neither political party has demonstrated intent or useful coordinated action to limit our skyrocketing government debt.  During the prior fiscal year, the government spent about $1 trillion more than it took in; the most recent fiscal year’s deficit is projected at $1.7 trillion – financed by additional debt at relatively high rates.  Unabated government borrowing may cause other problems including crowding out private sector borrowing or a shortage of buyers for US debt, potentially resulting in spiraling debt service.

Despite foreign and domestic pressures, US Gross Domestic Product just concluded its 5^th consecutive quarter of positive annualized growth.  Inflation as measured by the GDP Price Index has declined from 9.1% to 3.5% over the same period.  Broad equity market indices such as the S&P 500 have come off their highs but are firmly positive for the year.  Returns amongst equity indices such as the Dow and the Nasdaq 100 are widely dispersed with YTD returns ranging from flat to greater than 20%.  As long-term investors we seek ways to put markets into perspective and maintain an opportunistic approach.  The US REIT index has declined by over 11% YTD.  However, this sector has traditionally been a “bond proxy”.  The Fed’s final interest rate increase(s) may prove to be an inflection point for the real estate sector.  One bank index (“KBW”) is negative 25% for the year – however, certain components may be worth considering if balance sheet erosion abates.

Directly below is a table illustrating 2023’s YTD dispersion amongst asset classes: