Navigating Q2 2023: Investment Planning in a Shifting Economic Landscape
In the ever-evolving world of finance and economics, it's crucial to have a clear investment plan. In this blog post, we'll explore the current economic environment in the second quarter of 2023 and discuss the importance of investment planning in these uncertain times.
Key Takeaways: Reinforcing the Fundamentals
Profit-Based Recession Looms: Examining the potential for a profit-based recession alongside significant credit events.
Risk Assessment: Balancing the risk of recession versus the risk of inflation.
Fed's Unwavering Path: Analyzing the Federal Reserve's stance and its implications for the market.
A Year to Remember
The year 2023 has already made history with the unprecedented collapse of two major banks and a notable shift in the Consumer Price Index (CPI). Mortgage rates have soared to levels not seen since 1993. As we delve into the second quarter, it's evident that this year is shaping up to be memorable in economic terms.
Understanding the Current Economic Environment
As for the current environment, in the chart below, we have outlined our current economic probabilities from a rate of change perspective. Our investment framework is based on the incremental rate of change in both GDP and inflation, using a four-quadrant approach. To learn more about our investment strategies, read about our Tailored Financial Planning Approach - Client First Capital.
We currently have a 62% probability of staying in an environment of decreasing growth and inflation in Q2 2023. From the data, it is reasonable to expect to see a profit recession where companies will have a harder time maintaining profits, paying their debts, and maintaining existing valuations.
Our Investment Process
Our investment strategy hinges on a comprehensive risk management process, focusing on growth, inflation, and policy. Let's explore these aspects more deeply.
1. Examining Growth
Many countries teeter on the brink of recession, largely due to central banks' continuous efforts to curb inflation by raising interest rates. The United States may already be in a recession, with various economic indicators showing concerning signs. Real incomes, savings, consumption, and investment have all declined, painting a challenging economic picture. We emphasize the likelihood of a profit-based recession and larger credit events in this scenario.
2. Delving into Inflation
Although inflation peaked last year, core components like labor and shelter costs remain persistently high. As long as these core factors stay elevated, the Federal Reserve is unlikely to pause or pivot in its monetary tightening efforts. This tightening poses its own risks, especially for credit events in sectors such as credit cards and commercial real estate. We reiterate that these credit events may pose a more significant threat than high inflation.
3. Analyzing Policy
The Federal Reserve's outlook and commentary since 2000 have been marked by a series of misjudgments. This has eroded confidence in the Fed's statements, even as its actions remain consistent. The Fed's primary focus on controlling inflation may lead to disruptions in other parts of the economy. The recent 0.25% rate increase is one such example, further indicating a potentially rocky road ahead.
The first system to break was the banking system. A mismatch in durations caused a few regional banks to need help (SILCON VALLEY BANK). By having the treasury step in and create liquidity, we have undone a significant amount of quantitative tightening. We are still in the early season of a higher interest rate environment impacting the economy.
The Path Forward
Despite the challenges, there are strategies to navigate these uncertain waters. Gold remains a core holding in our model, as policy reactions may force the Fed to reverse course and adopt expansionary measures in the future.
To gain a deeper understanding of how we are adjusting our portfolios to help our clients achieve their goals, we invite you to watch our informative video. We are also offering a no-cost portfolio review, where we can assess your current investments and provide insights into key risks and their alignment with real economic data. If you're interested, please schedule a review of your investments with us.
