DAC Market Perspectives (Midyear 2023)

Kicking The Can Down The Road…

The rally in risk assets continued in the second quarter as the U.S. equity markets successfully fought off concerns about the U.S. banking system and worries that the Federal government would exceed its debt ceiling in June. Further confounding market bears, the U.S. economy continues to kick the proverbial recession can down the road as the U.S. labor market, consumer spending, capital expenditures, and, most importantly, an acceleration in U.S. GDP remain key leading indicators for future growth of the U.S. economy. However, there are some signs of weakness in areas of manufacturing and consumer spending, which, with tighter lending standards and the lagged effect of higher interest rates, will keep the dreaded R-word ‘Recession’ front and center as the Fed continues its fight to rein in inflation.

Thankfully, as the chart below of the year-over-year growth of the Consumer Price Index (CPI) indicates, inflation is decreasing in a symmetrical pattern similar to its rise. However, The Fed continues to maintain it wants an insurance policy – i.e., higher rates for longer – in order to guarantee that its efforts to stabilize prices will hold. At its recent Fed policy meeting in July, stronger employment and GDP data and a continuing rally in the stock market gave the Fed the green light for yet another 25-basis point hike. Since changes to monetary policy tend to act with “long and variable lags,” we expect the Fed’s most recent policy changes will continue to affect the U.S. economy well into 2024.

One unfortunate outcome of the Fed’s monetary tools is that while they are highly effective, they can also be quite blunt. Combined with the delayed and variable impact that rising interest rates have on the economy, the Fed’s task of right-sizing its monetary policy while, at the same time, not pushing the economy into a recession has historically been a tricky balancing act for the Fed. Many have characterized this as similar to driving a car down the highway at high speed while only looking in the rear-view mirror. Perhaps this is why, as many have feared, the Fed would continue to raise rates ‘until something breaks,’ which is what has occurred during previous rate cycles. This is also why we believe there could be downward pressure on economic growth and corporate profits heading into next year as the Fed attempts to ‘stick the landing’ on its 2% inflation goal.

Not surprisingly, when we review our outlook for corporate profits, expectations for 2024 S&P 500 operating earnings have fallen modestly since the start of the year. This means that the entire year-to-date gains for the S&P 500 – and the other major market indexes – have been from multiple expansion. For you P/E watchers, this translates to nearly all the increase in year-to-date stock prices has come from price (P) and not earnings (E) growth.

Therefore, if the current forecast for year-over-year earnings remains negative in the 2nd half of 2023, we believe that the combination of lower corporate profits (and higher interest rates) could pose a challenge for additional multiple expansion and, by extension, the continued outperformance of the equity markets. While a modest economic slowdown during the second half of 2023 would ease pressure on the Fed’s inflation expectations and long-term interest rates, real long-term Treasury yields remain negative after accounting for inflation. Further pressuring rates and raising borrowing costs, issuances (i.e., the sale of more bonds) by the U.S. Treasury are expected to grow in the 2nd half of this year. These bond sales are needed to support additional borrowing by the U.S. government and the U.S. Treasury to replenish reserves drawn down by the recent deficit battle.

In this environment, predicting higher returns on stocks may be challenging, particularly when the economy remains at or near full employment – a classic characteristic of late-cycle economic behavior. While it remains to be seen whether the U.S. economy enters a mild recession in the 2nd half of 2023 or early 2024, or as we hope, the current market rally keeps moving forward, we continue to maintain our focus on quality, which remains an integral part of DAC’s investment philosophy. We also remain confident in the ability of the companies in our clients’ portfolios to continue delivering robust cash flows and reward shareholders with rising dividends that will allow clients to weather any potential economic slowdown – or benefit from an economic recovery, as is our current outlook for the U.S. economy.

Thank you!
Your DAC Team


This material is for informational purposes only and should not be considered investment advice. The opinions expressed are those of Dividend Assets Capital. The opinions referenced are as of the 4 date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. You should carefully consider the investment objectives, potential risks, management fees, and charges and expenses before investing. There are no guarantees that dividend-paying stocks will continue to pay dividends. In addition, dividend-paying stocks may not experience the same capital appreciation potential as nondividend paying stocks. Data is deemed reliable, but DAC does not guarantee reliability or accuracy. Past performance is no indication of future results

Dividend Assets Capital, LLC (“DAC”) is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. More information about DAC investment advisory services can be found in its Form ADV Part 2, which is available upon request. DAC-23-037

Dividend Assts Capital, LLC is an independent, employee-owned wealth advisor specializing in high quality companies with a history of consistently increasing dividends. Built on a pioneering legacy, our goal is straightforward; achieve our clients desired outcomes through investments that provide sustainable and rising income with long-term capital appreciation. We partner with successful families, advisors and institutions delivering tailored services that adhere to fiduciary principles to provide…

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