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Freedman: Positive signs in the economy, but uncertainty still ahead

July 07, 2023

Eric Freedman, chief investment officer for U.S. Bank’s Asset Management Group, talks about what the second half of 2023 holds for the markets

After the worst year for stocks and bonds since 1969, more than a year of interest-rate hikes, and stubbornly high inflation, 2022 was challenging for just about everyone. What will the second half of 2023 hold? Eric Freedman, chief investment officer for U.S. Bank's Asset Management Group, talks about what he expects.

In June, the S&P 500 entered a bull market, inflation seems to be cooling, and the Fed decided to pause rate hikes. Are we turning a corner?

These are some pretty positive signs, and we’re watching all of them closely. We think the current environment is more about a resilient consumer than a significant change in momentum. Consumers have been spending more than most thought they would to start the year, and that has led to higher corporate profits.

The consumer price index (which measures the change in prices you pay for food, clothing and gas, among other things) showed that inflation slowed in May to 4%, which is around half of last year’s peak, but it’s still well above the Fed’s target of 2%.

We think we’re in the middle of a “chop” period between central banks attempting to put on the economic brakes through higher interest rates (which has largely already happened) and the impact of those increases taking shape. We do think that central bank interest-rate hikes will slow economic activity somewhat, but our U.S Bank Economics team thinks we will avoid a recession.

Fed Chair Powell acknowledged that rate hikes take time to take effect, and that inflation hasn’t reacted much to previous interest-rate increases. This is true around the world: the Bank of Canada recently increased rates to the highest level since 2001, and both the European Central Bank and the Bank of England are expected to raise rates this year.

"We think we’re in the middle of a “chop” period between central banks attempting to put on the economic brakes through higher interest rates (which has largely already happened) and the impact of those increases taking shape."

Eric Freedman, chief investment officer for U.S. Bank's Asset Management Group

Despite high interest rates on mortgages, auto loans and credit cards and higher prices for food, gas, rent and electric bills, consumers continue to spend. Why?

Consumers have been surprisingly resilient, and part of that is thanks to a still-robust labor market. People are still spending money they saved during the pandemic, the job market is still strong, and wages continue to rise. A strong job market and higher wages are of course good things, but they also mean higher inflation as companies pass on increased labor costs by raising their prices.

Right now, people are spending money on experiences – travel and entertainment (which makes sense as we were all cooped up for so long). They are spending less on furniture and other goods that they stocked up on earlier during the pandemic.

However, we are seeing some signs of slowing: people are putting more on credit, they are beginning to miss payments on their credit cards, and recent weekly jobless claims came in higher than expected. This could reflect a weakening labor market.

What will happen if people don’t slow down on their spending – even despite higher interest rates?

If consumers keep spending and businesses – particularly small- and medium-sized businesses – have a hard time maintaining workers to meet that demand, they will be forced to pay higher wages. That, in turn, leads to higher prices and inflationary conditions, which the Fed wants to avoid. Once workers expect perpetually higher wage increases, inflation could become embedded in the economy; this has happened in some countries, where it’s been really difficult to reverse inflation.

Why don’t you think we’re headed for a recession?

Our U.S. Bank Economics team believes we will avoid a recession thanks to a still-strong labor market that will slow very gradually vs. an abrupt stop in activity. They anticipate more people joining the workforce, a phenomenon called a rising labor force participation rate, and as more people re-enter the labor force and the economy cools off, wages will fall back to more historically consistent growth rates. Some in the press call a gradual slowdown in the economy a “soft landing,” which probably most closely aligns with our Economics Team’s assessment of where we will wind up.

Where should I be investing my money now?

Right now, we favor finding parts of the market that offer cash flow and yield. Examples include dividend-paying stocks, corporate and municipal bonds, and parts of the real estate market that are not tied to some of the more challenged subsectors like office and retail. We also like secular growth sectors like artificial intelligence, e-commerce, cloud computing and data security because they are well-positioned for longer-term growth.

It's also important to have a plan: what are your financial goals, and what will it take for you to achieve them? That’s much more important than what the markets or the economy are doing. We advise our clients to focus on their financial goals and not on timing the market.

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Freedman: Positive signs in the economy, but uncertainty still ahead

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Walnut Creek, CA

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