Denk Strategic Wealth Partners

Weekly eLetter 4/28//2023 – Closer to a Turning Point

I’ve been following Brian Wesbury’s commentary for over a decade. He’s the chief economist for the First Trust organization. And I’ve said, more than once, that he’s usually spot-on, and the one economist that I attempt to NEVER miss when he’s in town for meetings. Here’s his commentary for this week, used with his permission. (I’ll discuss it further in the market minute today.)

Brian Wesbury: In spite of weakness in some economic data, problems in the banking sector, and much higher interest rates, real GDP in the first quarter will almost certainly show moderate growth. Meanwhile, the S&P 500 is 15% higher than its low point in October 2022. And now, many are starting to believe that a recession isn’t going to happen. But we still think a recession is coming. Ultimately, recessions are about mistakes. In particular, there’s too much investment broadly throughout the economy or in some important segment of the economy, like technology back in 2001 or housing several years later. Once businesses realize they made a mistake – that the return on their investment will be too low – they ratchet back economic activity to bring the capital stock back into line with economic fundamentals. Almost always, it is government policy mistakes that cause this over-investment (or “malinvestment”). Then, when imbalances become too great, and policymakers change course after realizing their prior mistakes, the economy contracts and a recession becomes nearly inevitable. Sound familiar? We think so. The Fed opened the monetary spigot in 2020-21 while Congress and two different presidents passed out enormous checks to try to smooth over the damage done to the economy by COVID Lockdowns. Inflation has been the result. Now both fiscal and monetary policy have turned tighter. The unprecedented nature of policies during the COVID Era makes the timing of a contraction in activity difficult to predict, but, in our opinion, this contraction is almost certain. If anything, the notion among some businesses and investors that recession risk is declining may, by itself, contribute to greater risk, as it’s also consistent with less of a pullback in investment. It means businesses are not as widely coming to terms with past mistakes, which, in turn, means more problems ahead. This is why we think no one should get excited about a positive first quarter GDP report. As always, it tells us where the economy has been recently, not where it is going. The economy grew 2.9% in 2000; we had a recession in 2001. And real GDP grew 2.4% in the year ending in mid-1990, right before a recession. Most importantly, recent data show some early signs of weakness. Jobless claims have risen. Manufacturing production in March was lower than a year ago. Real (inflation-adjusted) retail sales are down from a year ago. In addition, keep in mind that the Fed used policy measures (like insuring more deposits) in the wake of the banking problems in March in order to prevent any widespread crisis in the financial system. In turn, that makes the likely path for short-term interest rates, for at least the next several months, higher than most investors anticipate. We think the futures market is correct in anticipating another 25 basis point hike in May, just like we had in February and March. But the markets are not as prepared for another rate hike in June, which we think is more likely than not. Inflation remains a problem and the April inflation print, arriving May 10, should confirm that problem. The federal funds futures market expects the Fed to end the year with short-term rates lower than they are today; we think they end up higher than today at year-end, instead. Where does that leave equity investors? We understand the desire for optimism, but our model still says equities are overvalued. There will come a time to get bullish, but that’ll be after the recession starts, not before.

NB: This report was prepared by First Trust Advisors L. P., and reflects the current opinion of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.

Ron’s Market Minute — Wesbury Is Right

The first measure of Q1 GDP came in at 1.1% according to yesterday’s WSJ. That’s definitely considered ‘growth’. Now that’s rather less than estimates of 2.0% Growth and a lot less than Q4’s 2.6% rate, but judging by yesterday’s market action, it excited investors, nevertheless. So, what’s happening here? I’ve seen predictions that range from a recession that’s supposed to already be here to hopeful predictions that despite an obviously slowing economy, we will somehow manage to skirt this much-anticipated recession. The slowing data gives weight to the hypothesis that the FED may indeed pause its aggressive rate hikes, (bulls hope for this!) and consumer demand seems to be holding tentatively. However, inflation is still WAY above the FED’s much-hyped 2% level, and that makes us think that higher rates will be with us for a while, and the economy will likely continue to slow.

As an investor, there are certain areas that tend to hold up better than others during a weak or recessionary economy, and we’ve been studying several of these areas and making a foray into them. These include defensive stocks; companies that provide essential goods or services such as healthcare, utilities, and consumer staples. Companies in these sectors tend to have stable revenues which can help them weather downturns. Also, bonds — and even the strongest bulls tend to give them serious consideration as investors flock to bonds during downturns.

I’ll round out the research areas by adding in gold and dividend-paying stocks. Like bonds, gold has long been considered to be a safe haven during recessionary economic times. As I said, we’ve already ventured into some of these areas. A strong up day in indexes like yesterday certainly stokes our desire to be more optimistic. Like Wesbury, we believe there will be a time to become bulls, but we do not believe that time is yet here. We are cautiously invested and moving more toward areas that historically are likely to cushion the potential downswings ahead of us.

A special note: Thanks for your prayers for my brother and his wife. They were much appreciated. He passed away unexpectedly. The link to the eulogy is here:

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite D406A
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk


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