Q2 2023

July 11, 2023

The stock market’s strength this past quarter confirmed the direction of interest rates is all that matters. For the first time in over a year, the Federal Reserve did not raise interest rates. This alone gave credence to the thinking that interest rates will be peaking soon and pushed stock prices higher. They decided to let previous rate increases work their way through the economy. The hope is that what has been done will be enough to slow the economy and cool upward pressure on prices.

I have been assessing current conditions from the bottom-up; listening to what companies are saying about current conditions and the future. What I am finding is current business conditions vary widely (I’ll talk about this in a moment), but management teams are almost universally cautious about the near term.

I am also hearing many comments on price pressures, saying margins are stabilizing as raw input inflation abates. Not surprising as most raw materials (e.g., oil, copper, lumber) are significantly cheaper today than they were a year ago.

Does this mean the Fed has been successful? Not necessarily. The labor market appears to be the Fed’s Achilles heel.

You may have noticed since the quarter’s end, the market has had some sharp down days. Strong reported jobs numbers were the cause. The economy produced almost two times more new jobs in June than had been expected. The labor market remains strong.

The Fed knows tight labor markets can create structural inflation. This is what is known as a wage-price spiral. They have repeatedly told the market that the labor market is one of the key indicators they are watching. Hence, a strong June jobs number dashes the market’s hope that interest rates are peaking.

You might find it interesting to hear a bit of a summary on areas of strength and weakness in the economy. As I said, we are hearing widely varied stories on business conditions. Here is a glimpse into some of what we are hearing:

- Consumer electronics markets are in a recession, bordering on a depression. Demand for these goods has collapsed. This is everything from computers to gaming consoles, to TV’s. From a more generalized perspective, what we are hearing is that consumers have stopped buying discretionary items except for cars and vacations. One way to look at this is everyone upgraded these items during the pandemic; another is to assess this as an indicator of consumer cautiousness. I suspect both are causes.

-The auto industry is still in a full steam ahead recovery mode. Companies have not been able to keep up with demand due to continued component shortages. Something of a good/bad news story. This is simply a contra-trend industry due to specific issues surrounding supply.

-The housing industry was in a full recession, but surprisingly more recent numbers on housing paint a picture of recovery. Interesting how housing prices have held up in light of higher mortgage rates. Employment trends may be offsetting the impact of higher rates, we’ll see.

-The entertainment and hospitality businesses are booming. Consumers may be more cautious, but they are clearly ready and willing to go out and are not canceling their vacations. Still seeing the post-pandemic effect of being couped up. People want to get out, and they are.

-Technology is a mixed bag with semiconductors continuing to be strong, but software companies seeing revenue growth slow. Personal computer sales have fallen off a cliff, but data center spending is still strong. As I said, a mixed bag.

There is no clear macro trend. However, if the Fed remains committed to fighting inflation, they’ll have to slow the economy further. Higher rates are inevitable. Our view remains that a positive long-term outlook for stocks is wholly based on the Fed’s resolve.

I hope you all have a wonderful summer filled with great experiences!

Sincerely,

Mark Hoonsbeen, CFA
Principal
Nicollet Investment Management
800 North Washington Ave, Suite 150 Minneapolis, MN 55401
Phone: 612-915-3033
Email: markh@nicolletinvest.com