US Economy Overview: Heading to 2024
Economic Performance and Inflation Trends
In 2023, the US economy continued to grow, with low unemployment rates and moderating inflation. Consumer spending grew by 2.8% in Q4, a slight dip from Q3's 3.1%, yet remained a key economic driver. Business investment also saw a rise to 1.9%, up from 1.4%. Inflation edged up by 0.3% in January, with an annual increase of 3.1%, slightly above the expected 2.9%. This was still a decrease from the previous month's 3.4%, continuing the downward inflation trend from 2021. Despite lower inflation, challenges for early 2024 include high consumer debt, high interest rates, near recessions in Europe and China, and ongoing geopolitical conflicts.
Growth Amidst Interest Rate Hikes
Despite 11 interest rate hikes since March 2022, culminating in a rate range of 5.25-5.5%, the US maintained robust economic health.
The Q4 2023 GDP outpaced expectations with a 3.3% YoY growth rate, largely fueled by consumer spending and supported by an increase in disposable income.
Government spending and net exports also contributed to GDP growth, averaging a 2.5% increase on GDP throughout the year.
Market and CPI Analysis
The US economy still faces a lot of uncertainties in 2024, including potential reductions in consumer savings, rising debt-to-income ratios, persistent high- interest rates, impacts of a strong US dollar on trade, and later, the presidential election. Further concerns stem from economic downturn risks in Europe and China and ongoing geopolitical conflicts.
CPI Detailed Insights for January 2024
January's CPI rise was largely driven by housing costs, which represent a significant portion of the CPI and saw a 0.6% month-over-month increase— the most substantial hike in housing prices in a year. Notably, there were also sizeable increases in food and medical services prices.
In February 2024, CPI showed an increase of 0.4%. The annual inflation rate was 3.2%, which was higher than expected. The core CPI, which excludes volatile food and energy costs, also rose by 0.4% month-to-month, surpassing the forecast of 0.3%. Rising gas and housing prices were significant contributors to this inflation.
Historical patterns call for caution in policy adjustments to avoid a repeat of past economic downturns, emphasizing the importance of measured responses to interest rate changes.
CPIs of the first two months in 2024 suggests the US economy's overheated state is still impacting consumer prices, with the Federal Reserve's rate hikes not yielding the expected inflationary curb. This pushed the rate cut expectation even further.
(Source: U.S. Bureau of Labor Statistics)
Federal Reserve Holds Steady
Jerome Powell, the Fed Chairman, focuses on controlling inflation and promoting employment. He advocates for high interest rates to manage inflation while considering employment and price stability. This approach aims for a “soft landing” of the economy, avoiding overheating or recession, and ensuring steady growth. Stakeholders are advised to prepare for a cautious and measured approach to monetary policy through the upcoming periods.
Current Stance of the Federal Reserve
Federal Reserve's Policy Rate: As of January 31, 2024, the rate remains unchanged at 5.25% to 5.5%. This is the fourth consecutive FOMC meeting without an interest rate change. The FOMC continues to seek more definitive evidence of maintaining a 2% inflation rate before contemplating rate changes
Chairman's Position: Jerome Powell acknowledges progress but does not commit to a future rate cut schedule, indicating a hawkish pivot.
Calls for Prudence:
Neel Kashkari, Minneapolis Fed President, suggests that 2-3 rate cuts may be suitable for the year.
Adriana Kugler, Fed Governor, sees signs of slowing inflation but isn't ready to endorse rate reductions.
Susan Collins, Boston Fed President, calls for more proof of inflation containment before adjusting the policy stance.
Investor Implications and Monetary Policy Projections
Major financial entities, including Goldman Sachs, Blackrock, and CBRE, are now projecting rate cuts possibly in mid-2024 or later, a significant deferral from earlier expectations.
Strong Job Growth Continues
Despite reaching a peak in wage growth post-pandemic in 2022, the rise in salaries is now realigning with pre-pandemic levels, influenced by quantitative tightening measures. The cumulative wage growth since 2020 has paralleled the increase in consumer prices, suggesting that the average American's purchasing power has largely remained stable despite inflation.
Employment Growth and Wage Trends
In January, the U.S. saw a significant increase in nonfarm payroll employment, adding 353,000 new jobs and maintaining an unemployment rate at a historically low 3.7%. Throughout 2023, the economy added 2.7 million jobs, bringing nonfarm employment to 157.2 million. Since the COVID-19 pandemic began in February 2020, employment has risen by around 4.9 million.
Under President Biden's tenure starting January 2021, approximately 14.3 million jobs were added. Despite these gains, wage growth has decelerated, returning to the pre-pandemic level of 3.1% as observed by job platforms like Indeed, indicating a shift back to a normalized pre-pandemic wage growth rates.
Unemployment Rate (From Jan 1980 to Jan 2024)
Wage Dynamics and Living Costs in the Post-Pandemic Economy
The United States has maintained historically low unemployment rates with only a slight uptick recently. The wage growth rate has seen a reduction to 4.4% by September 2023.
In terms of purchasing power, wage increases since January 2020 have closely kept pace with the rising cost of living, with wages growing by 17.6% alongside a Consumer Price Index increase of 18.3%.
This trend suggests that the impact of inflation on the average American's buying power may not be as significant as perceived.
Overall Debt Level Rises, but Not Alarming
The resilience of the U.S. economy is partly attributed to persistently low mortgage rates, which have remained so even amidst Federal Reserve's rate hikes. According to Gregory Daco, EY's chief economist, these rates have buffered the economy against potential disruptions, contributing to its stability.
Unlike in Canada, where variable-rate mortgages are prevalent, the U.S. mainly employs fixed-rate mortgages, offering homeowners protection against rapid interest rate changes. This method ensures less impact on household finances from market volatility, playing a crucial role in upholding economic stability.
Overall Debt Level
Despite a modest increase in overall borrowing in Q4 2023, remaining below pre-COVID levels, the overall debt level is not considered alarming. Americans accumulated significant savings during the pandemic, contributing to a potential "soft landing" for the economy.
Household Debt: The debt increased by $212 billion to $17.5 trillion. However, when excluding the impact of the Covid period, the debt as a percentage of disposable personal income GDP is at a historical low, suggesting that the debt levels are manageable.
Mortgage Rates: Most U.S. homeowners benefit from fixed mortgage rates for the life of the mortgage, with 90% on a fixed rate, reducing the impact of interest rate hikes.
Debt Service Payment: The ratio of household debt service payments to disposable personal income remains low, suggesting that debt payments are not excessively burdensome relative to income.
Loan Delinquencies
Current Trends: A slight increase in loan delinquencies of all types was observed in 2023, yet they remain below pre-pandemic levels, indicating a stable credit environment.
Savings and Consumption
Excess Savings: The U.S. saw a substantial increase in excess savings due to government support and stimulus policies during the pandemic, with a peak accumulation of $2.1 trillion.
Savings Drawdown: By the end of 2023, $1.7 trillion of the excess savings had been depleted, with the remainder expected to be used up by mid-2024, potentially affecting consumer spending and economic growth.
Aggregate Personal Savings vs. Pre-Pandemic Trend
Future Risks
Interest Rates: Continued high rates could pressure corporate short-term debt and lead to increased cash flow pressures, pressuring equity valuations.
Employment and Wages: To alleviate cash flow pressures, businesses might reduce hiring or increase layoffs. This, along with the depletion of excess savings and normalization of wage growth, could lead to reduced consumption. Consequently, there could be a slowdown in economic growth.
Canada Economy Overview: Heading into 2024
Anticipated neutral shift in the Canadian economy for 2024, with 1.1% growth in 2023, below the 2% potential. Bank of Canada holds a hawkish stance with rates at 5.00%, signaling clear policy direction.
Inflation, largely driven by food and shelter costs, expected to remain below the 2% target through end of 2024, with significant CPI slowdown noted in January 2024 due to lower gas and food prices.
Inflation and GDP Insights
In 2023, Canada experienced an average annual inflation rate of 3.9%, a significant decrease from the 40-year peak of 6.8% seen in 2022. The Bank of Canada anticipates that inflation will hover around 3% for the first half of 2024, with a goal to achieve a 2% inflation rate by year’s end. It’s worth noting that when we exclude the cost of shelter, which has a substantial impact on overall inflation, the inflation rate aligns more closely with the Bank of Canada’s target.
Economic Performance
In 2023, Canada's economy saw modest growth, with a 0.2% increase in real GDP in November and stable levels in December, leading to an overall annual growth of approximately 1.1%, largely attributed to population growth amidst a decline in per capita GDP. The year marked one of Canada's weakest performances since 2020, despite a 1% annualized growth rate in the fourth quarter, impacted by a contraction in goods-producing industries and a public sector decline due to a workers' strike in Quebec.
December 2023 CPI rose by 3.4% year-over-year, driven by food, shelter, and oil prices. January 2024 saw CPI growth slow to 2.9%, indicating a continued but slower price increase due to high base effects. Continued decline in per capita GDP over six quarters, with growth mainly driven by population increase, differing from U.S. trends.
GDP per Capita (change from peak) vs. Inflation
Migration-led Population Boom
In Q3 2023, Canada's population reached a historic high of 40,528,396, boosted by the arrival of 107,972 immigrants in the third quarter. The country plans to welcome nearly 1.5 million immigrants between 2024 and 2026. Alberta is seeing significant population growth through interprovincial migration, while British Columbia and Ontario have faced net losses. In 2022, the population increase exceeded 1 million, a 2.7% rise and the sharpest since 1957.
The 2023 population growth continued robustly with over 1.2 million added, driven predominantly by new immigrants and temporary residents. This growth matches the average annual rise over the last two decades and reflects a strategic approach to immigration amid global demographic shifts, on average, Canada's population growth surpasses the OECD average by 5x.
To manage the population surge that intensifies housing shortage, Canada has announced to reduce the issuance of foreign student permits by 35%.
Job Market Softening Expected Ahead
The unemployment rate, when viewed over a span of 25 years, reveals significant fluctuations, with a sharp rise noted around 2020 and a subsequent decrease to current levels below pre-2020 figures. This long-term perspective highlights the resilience and adaptability of the labor market in the face of economic challenges.
The Canadian labor market in January 2024 displayed a net increase in employment with 37.3k jobs added, yet it saw a decline in full-time positions by 11.6k and a rise in part-time roles by 48.9k. This transition reflects a nuanced job market where the nature of employment is as significant as the quantity.
Concurrently, the unemployment rate edged down slightly to 5.7%, a subtle change that masks a larger narrative of shifting labor dynamics. The reduction in unemployment was not so much a signal of robust job creation but rather the result of a slight decrease in labor force participation, which dipped to 65.3% even as the population increased by 126k and only 18k new individuals entered the workforce.
Impact of Immigration on Labor Market
In response to labor shortages, Canada's lenient immigration policy in 2022 facilitated an influx of temporary workers, especially during the tight labor market between 2021 and 2022. This policy has had a mixed impact; while it has brought some relief to labor-strapped sectors, it has also perpetuated shortages in others, with 61% of the market still experiencing a higher demand for workers than before the pandemic.
Additionally, the increase in the immigrant population has led to a surge in both the demand for housing and broader economic needs, which, in turn, fuels the labor market. Notably, a significant portion of these new immigrants are investing in their futures through education, indicating a longer-term approach to integration into the Canadian job market.
Rising Financial Vulnerability in Canada
Financial vulnerability among Canadian households is intensifying, marked by increasing debt loads and impending mortgage renewals. By Q3 2023, household debt surged to 181.6% of disposable income, equating to $1.82 in credit market debt for every dollar earned.
This precarious situation is exacerbated by rising delinquency rates on nonmortgage debts, hinting at potential upticks in mortgage delinquencies. An unprecedented 280,000 mortgages from early 2021 face renewal, with RBC and Scotiabank indicating $91.1 billion in loans due in 2026, highlighting a critical juncture for Canadian financial stability.
Debt Payment Challenges and Savings Trends
Delinquency rates across various loan types are climbing, as depicted in a line graph that accentuates the upticks in credit card and auto loan delinquencies. This graph marks a concerning trend as more Canadians struggle to keep up with their debt payments.
Meanwhile, a discussion on aggregate personal savings in relation to pre pandemic levels, though not detailed here, is essential for understanding shifts in financial behavior since COVID-19.
Mortgage Landscape and Debt Comparisons
Household debt service payments, indicating the proportion of disposable income spent on debt, show that debt accumulation outpaces income growth in households.
Comparative analyses reveal differences in debt burdens between the U.S. and Canada. In Canada, 74% prefer fixed-rate mortgages, with a notable portion on floating rates and nearly half having a 5-year term. Anticipated mortgage renewals peak in 2025-2027.
Opportunities Ahead
Companies are increasingly staying private for extended periods amidst a challenging economic environment, marked by high interest rates and tightening cash flows. Furthermore, as economy slows down, it might lead to the narrowing of revenue and profit margins.
As a result, equity valuations have dipped, and the climate for Initial Public Offerings (IPOs) has soured, leading to less exit activity and smaller volumes raised through IPOs. Consequently, there is a burgeoning demand for primary market financing as businesses weigh the pros and cons of equity versus debt.
Private Debt and Equity Opportunities
The retreat of banks from lending and the tightening of credit have paved the way for private debt and equity financing to flourish. The alternative investment market has expanded, with private debt now accounting for 12% of the universe and totaling over $1.6 trillion globally. Opportunities abound, particularly in direct lending, distressed assets, and special situations, indicating a robust ecosystem for private financing.
Yields and Deal Activity in Private Markets
Private debt investments are attracting attention with their yield premium, offering the potential for higher returns. Specifically, the lower-mid-market yield has been notably robust, with yields soaring over 12%.
Mid-size U.S. businesses have encountered borrowing costs around 12%, reflecting the peaked interest rate hikes of 2023. The expansive market size offers a broad array of choices for investors seeking competent fund managers and promising private debt instruments.
Private Equity Market Dynamic
Private Equity Exits and Liquidity: The exit landscape for private equity investments is showing a downward trend, hitting a record low. This reduction in traditional exit strategies has heightened the demand for liquidity, as investors seek alternative means to recoup and maximize their investments.
Valuation Fluctuations and Liquidity Pressures: Valuation dips have been observed alongside the demand for liquidity, where the median net IRR for various acquisition years is juxtaposed with debt and equity metrics. Trends in capital calls and distributions over time reflect the shifting landscape of investment returns and the corresponding liquidity requirements.
Adjustments and Opportunities in Private Equity
Market Slowdown: The private equity sector is slowing, with transaction activity falling significantly due to economic pressures like rising interest rates, inflation, and geopolitical uncertainty. This has resulted in a 65% reduction in transactions in 2022 and an additional 40% decrease in 2023.
Valuation and Transactions: Valuation adjustments in the secondary market have led to average private transaction multiples decreasing to 11.2x. The market is now favoring more affordable add-on acquisitions and privatizations, with take-private deals making up a larger share of transaction value.
Liquidity and Investment Strategy: Current market conditions offer strategic investment opportunities due to liquidity needs. The difficult IPO market has limited exit strategies for shareholders, many of whom are struggling with debt and negative cash flows. This has increased the supply in the secondary market, allowing investors to find transactions with attractive valuations.
Secondary Market Dynamics
Market Growth: The secondary market has been charting a significant increase in net asset value, indicating a rise in market volume over time. This underscores the market's burgeoning significance in the broader investment landscape, with more investors looking towards these avenues.
Evolving Role of Data Centers
Data centers now play a crucial role beyond storage and connectivity, becoming essential for AI, machine learning, and high-performance computing. They form the digital infrastructure's backbone, supporting numerous industries.
Market Demand and Pricing: Data center costs are rising due to high demand and limited supply, with CBRE forecasting a 10% to 15% price increase by 2024. This is coupled with the need for better network capacity and power supplies to support expanding operations.
Power Consumption and Rental Rates: Data centers' power consumption is charting an upward trajectory, with a compound annual growth rate (CAGR) of +13.0%. This aligns with escalating energy demands as data centers grow in size and complexity.
Rental Price: Concurrently, the average asking rental rates in the primary market are on an incline, reflecting an upward cost trend year over year.
Average Asking Rental Rate with Y-o-Y % Change for Primary Markets
The distribution of power consumption across different entities is shifting markedly towards hyperscale, with projections indicating they will claim a more substantial portion by 2030. This underscores the increasing influence and operational demands of major tech companies in the data center market.
Investment Implications from Industry Leaders
NVIDIA's remarkable financial achievements, marked by a 265% increase in revenue and a 769% rise in net profit, have uplifted market sentiment, propelling AI-related stocks and enhancing market activity. This showcases the influence leading corporations have on shaping investment landscapes and market movements.
In the realm of real asset investment, particularly digital infrastructure, data centers stand out as indispensable assets. Expected increases in rental rates and power consumption underscore substantial opportunities for industry participants, prompting suppliers, hosting centers, and large tech firms to pursue strategic consolidations.
Investment Landscape Evolution
The investment strategy of the Canada Pension Plan Investment Board (CPPIB) has evolved significantly from FY1999 to FY2023. There's a clear trend of reallocating assets towards private equities and real assets, moving away from public equities and credit investments. This shift underscores a strategic pursuit of higher yields and potentially lower volatility associated with private market investments.
CPPIB Asset Mix FY1999-2023
Source: CPPIB annual report from FY1999-2023
Performance Across Asset Classes
The historical performance data spanning from 2013 to 2023 (November) indicates varying levels of returns across different asset classes. These trends provide insight into the changing nature of asset class performance over a decade, reflecting broader economic cycles and shifting market conditions.
Morgan Stanley Tactical Asset Allocation Guidance
Morgan Stanley's tactical asset allocation recommendations outline a nuanced approach to investing:
Equities: Suggests underweighting North American, U.S., and Canada small caps due to market performance, while keeping U.S. large caps and international equities at market weight. Emerging markets are favored with an overweight status for their growth potential.
Fixed Income: Advises underweighting government bonds and cash/money market strategies, seeing low returns. U.S. investment grade, high-yield bonds, and emerging markets debt are at market weight, with securitized credit overweight for better returns.
Alternatives: Real estate/REITs are at market weight, indicating a standard approach. Private real estate is overweight, highlighting the higher return potential in this area.
RISK DISCLOSURE
Investing in securities and other financial products involves a variety of risks that may result in partial or total loss of principal. The strategies and market insights discussed herein are subject to, among others, the following risks:
Market Risk: The value of securities can fluctuate daily due to economic, political, and market-specific factors. There is no assurance that any investment strategy will achieve its stated objectives.
Liquidity Risk: Some investments may be less liquid than others or illiquid, meaning they might be difficult to sell within a reasonable timeframe, or without significantly impacting their price, potentially preventing a sale at or near their stated value.
Capital at Risk: Some investments may include a high degree of risk, including the possibility of total capital loss. Investors may not recover the initial amount invested, and past performance is not indicative for future returns, as actual outcomes may differ materially from historical results.
Credit and Counterparty Risk: The possibility exists that issuers or counterparties may fail to meet their financial obligations.
Currency and Political Risk: Investments in foreign markets may be adversely affected by fluctuations in currency exchange rates, changes in governmental policies, or political instability.
Concentration Risk: Non-diversified portfolios, or those concentrated in a specific sector or asset class, may experience higher volatility if conditions affecting that area deteriorate.
Derivatives and Leverage: The use of derivative instruments or leverage can amplify both gains and losses, and may introduce additional risks including valuation, correlation, and counterparty risks.
ESG and Impact Investing Considerations: Strategies that incorporate Environmental, Social, and Governance (ESG) or impact investing factors may underperform relative to broader market benchmarks if market sentiment shifts against the favored sectors or themes.
Lack of Information or Operating History: Investments in exempt securities with limited operating histories or information may carry additional risk, as there may be insufficient data to assess the stability, performance, or management track record. The absence of a proven history increases the uncertainty and potential for unforeseen challenges.
Investors should be aware that these and other risks can cause investment results to vary significantly from the objectives set forth in this publication. No assurance is given that any investment strategy or market insight will be successful, and all investments carry inherent risks, including the potential loss of principal.
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DISCLAIMER
The information contained herein is for general informational and educational purposes only and does not constitute an offer, solicitation, or recommendation to buy or sell any securities or financial products. The market insights, opinions, and analyses expressed in this publication are those of the author(s) as of the date of publication and are subject to change without notice. They are not intended to be, and should not be construed as, personalized investment advice or a substitute for professional advice tailored to your specific financial circumstances. Neither Enoch Wealth Inc. nor its affiliates shall have any liability or obligation to any party for any loss or damage arising directly or indirectly from the use of, or reliance on, the information provided herein.
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