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The Second Half of 2023 May See an Uptick in Volatility

John E. Chapman August 01, 2023

A couple of weeks ago Clearwater Capital released our full Mid-Year Update report of our Outlook 2023. Even as the U.S. equity markets continue to rally, we remain cautious. Our base case calls for a short and shallow recession to develop later this year, or early in 2024.

Last week, the Fed raised interest rates by another 25 basis points as was widely expected. This brings the total number of rate hikes to eleven over the past 16 months. As of this writing the futures market suggests a 50% chance that the Fed will raise rates once more before the end of the year. While Fed Chair Jerome Powell was characteristically vague at his press conference following the FOMC meeting, one can assume that further tightening is likely as long as inflation runs at levels above the Fed’s target of 2%.

While the rate of inflation has been declining since hitting a high of 9.1% a year ago, one must remember that this does not mean prices are coming down – only that the pace in which they are increasing has slowed. The cumulative total inflation now stands at 16.6% since January 2021 when the rate of inflation started to accelerate. This simply means that consumers must now spend $1.17 to purchase the same items that cost $1.00 just two and a half years ago.

Equity markets appear to be increasingly convinced that the Fed will bring inflation down without triggering a recession. This is referred to as a “soft landing” and we remain skeptical. Because of the lagged and varied impact of higher interest rates, we believe the degree to which the economy will eventually slow will be greater than many investors currently expect.

Mortgage rates remain elevated, the leading economic indicators have been declining for fifteen straight months, consumer debt is trending towards all-time highs, and corporate bankruptcy filings are double what they were at this point in time in 2022. WTI crude oil prices have risen steadily over the past month with the price per barrel now over $80. This, and the persistent strength in the services sector, will make further declines in inflation more difficult to come by in the months ahead.

On the bright side, corporate earnings have remained resilient and consumer confidence recently ticked up. Equities have had a nice rally this year, but the indices have been dominated by a handful of mega cap tech companies with exposure to artificial intelligence. Another positive for the economy is the narrowing of corporate bond spreads over Treasuries. However, most yield curves are significantly inverted which historically signals trouble for the economy.

Our view is the Fed’s battle with inflation will be quite challenging in the second half of the year, causing policy makers to keep interest rates higher for longer than is widely expected. This, along with a wide range of trends that are likely to pinch U.S. consumers in the months ahead, leads us to believe there could be trouble for the economy later this year. We think risk assets could be vulnerable when this becomes apparent to investors who have bid equity prices to their highest levels in over a year.

Please refer to our Mid-Year Update for a detailed discussion of current conditions.

John E. Chapman

disclosure

THIS COMMENTARY HAS BEEN PREPARED BY CLEARWATER CAPITAL PARTNERS. THE OPINIONS VOICED IN THIS MATERIAL ARE FOR GENERAL INFORMATION ONLY AND ARE NOT INTENDED TO PROVIDE OR BE CONSTRUED AS PROVIDING LEGAL, ACCOUNTING, OR SPECIFIC INVESTMENT ADVICE OR RECOMMENDATIONS FOR ANY INDIVIDUAL. ALL ECONOMIC DATA IS DERIVED FROM PUBLIC SOURCES BELIEVED TO BE RELIABLE. TO DETERMINE WHICH INVESTMENTS MAY BE APPROPRIATE FOR YOU, PLEASE CONSULT WITH US PRIOR TO INVESTING. INVESTING INVOLVES RISK WHICH MAY INCLUDE LOSS OF PRINCIPAL.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities, insurance products, or to adopt any investment strategy. The opinions expressed are as of the date of writing and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by Clearwater Capital Partners to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. S&P 500 is a registered trademark of Standard & Poor’s Financial Services, a division of S&P Global (“S&P”)  DOW JONES, DJ, DJIA and DOW JONES INDUSTRIAL AVERAGE are registered trademarks of Dow Jones Trademark Holdings (“Dow Jones”). The two main risks related to fixed-income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments.

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