Opportunities on the Horizon: Investing Through a Slowing Economy

Overview | WEALTH OUTLOOK 2023 | MID-YEAR EDITION | 17 FIGURE 12 : US Multi-Family Apartments Under Construction vs Related Construction Employment Y/Y% 700 900 1100 1300 1500 0 200 400 600 800 1000 '89 '92 '95 '98 '01 '04 '07 '10 '13 '16 '19 '22 Thousands Thousands Recession Housing units under construction 5 or more units (SA, Thous, units, EOP) All employees: heavy & civil engineering construction employment (SA, Thous) Source: Haver Analytics as of May 22, 2023. Gray areas are US recessions. Less inflation on the horizon We believe headline US Consumer Price Index (CPI) inflation is set to slow to 3.5% by the end of 2023, down from 6.5% at the end of 2022. A further decline is likely to get close to the Fed’s 2% target in 2024. Getting there will require some economic pain. Consider how zero policy rates helped finance a record number of multi-family housing construction activity since COVID struck ( FIGURE 12 ) . These “long cycle” apartment projects will be delivered later this year and all through the next. Sharply higher financing costs suggest there will be a collapse in new construction and related unemployment will follow. On the other hand, the increased supply of rental units should significantly cool shelter price inflation, a key CPI component that is still reaching new cycle highs at mid-year 2023. More volatility to come As we write, the US Congress has just passed a suspension of the statutory debt ceiling through January 2025. This will open the floodgates to a stepped up round of borrowing as the US Treasury replenishes its nearly depleted cash balance. Aside from borrowing to finance US deficits, net new Treasury bill issuance in the months ahead could exceed $300 billion and $1.3 trillion across all US Treasury issues by the end of 2023. At presently high yields, the borrowing could displace other asset classes and temporarily boost the US dollar. If so, we would see it as a stronger opportunity to add to non- US assets for the years to come. For example, we have already added overweights in Brazil and emerging markets in Asia (See Currencies ) . The situation for the US is also quite different from 2011 when the S&P 500 fell more than 15% after a debt ceiling agreement was reached. In the period that followed, US shares recovered sharply and outperformed the world during the next decade. However, at the time of that fiscal deal, the US unemployment rate exceeded 8.5% and the Fed’s policy rate hugged zero. US corporate profits were still deeply depressed from the Global Financial Crisis of 2007-2008. Therefore, profits rose rapidly in the years that followed. Today, the Fed is still restraining the US economy and US corporate profits are high but on the decline. For these reasons, we don’t believe large cap US equities will lead global equity returns in the coming few years. Our future set of potential opportunities Last year, soaring bond yields collapsed growth stocks. This year, growth-style investing recovered. The gains, however, have been concentrated in the largest firms with the strongest balance sheets. The S&P 500 IT sector has returned 35% year to date while the S&P 600 IT sector has returned more than 15%. We maintain overweight positions in long-term growth drivers such as cybersecurity and look