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Deflation and economic growth now suggested by the U.S. Fed

Deflation and economic growth now suggested by the U.S. Fed

Let me share some fresh insights affirming a view we have articulated since November last year: A recession is not inevitable, and 2023 could be a stellar year for stocks, particularly if deflation is accompanied by even anaemic economic growth.

Reflecting upon the validating and impressive performance of S&P500, which has risen over 20 per cent, and NASDAQ100, which soared over 40 per cent since early November, it now becomes crucial to re-evaluate the prospects of a potential recession.

At the beginning of the year, consensus held that the Federal Reserve’s (Fed) proactive interest rate hikes would ignite a recession by now. This projection has yet to transpire, and it seems now quite possible that it won’t.

It is true that parts of the U.S. economy are experiencing a gradual ‘cooling’, but this aligns with the U.S. Feds strategic intentions to mitigate inflation.

Some commentators now suggest the crucial determinant in preserving a balanced, inflation-curbing slowdown that doesn’t torpedo the economy rests on whether corporates resort to staff layoffs. Fortunately, there’s increasing evidence that the difficulties companies experienced replacing staff that were laid off during the pandemic and the shortage of labour currently acknowledged has meant companies are deciding to preserve jobs and find cuts or efficiency improvements elsewhere.

Reported examples include instances of freight railroads witnessing lower shipping volumes, construction firms downsizing their equipment purchases, and a vending machine company’s customers bargaining prices.

Perhaps the most high-profile example is Apple Inc’s stated preference against large-scale layoffs amidst economic turbulence.

Despite earlier job cuts by its competitors, Apple’s strategy has been to keep its workforce intact. Instead of downsizing, the company has opted for tighter cost management and strategic hiring, as echoed by their chief executive officer (CEO) Tim Cook earlier this year.

Most businesses have followed suit this spring, with significant investments in sectors such as chip-manufacturing plants, electric vehicle factories, and expensive aircraft purchases. Moreover, according to one reported survey by Vistage, about two-thirds of U.S. small business owners have adopted cost-cutting strategies in the past six months, with similar plans.

It’s easy to see how such strategies, combined with eschewing job cuts, enable businesses to prepare for a potential slowdown, and an economic rebound.

Historically, businesses have found the process of layoffs and rehiring tedious and, more recently, businesses have found rehiring extremely challenging. By retaining workers, businesses are enabling steady consumer spending, albeit at a slower pace.

The approach appears to be gently cooling the economy and forestalling the widely predicted and much-feared recession.

Meanwhile, multi-decade high interest rates are giving some much-needed additional income. According to Commerce Department data through June, American households are earning an extra $121 billion from income on investments annually versus a year earlier.

The above evidence supports our thesis 2023 would be a year of declining inflation without the U.S. plunging into a recession.

Indeed, none other than Fed Chairman Jerome Powell recently mirrored our view stating, the initial signs of disinflation are appearing without any substantial costs to the labour market.  This is a highly encouraging confirmation leading to our ‘Goldilocks’ scenario; deflation coupled with economic growth.

Since the 1970s, this combination has proven beneficial for equities, particularly for innovative growth stocks.

ADDENDUM 18 August 2023:  While this post reflects our long term (strategic) view, which is constructive, you will note in earlier and subsequent posts we have outlined a scenario suggesting the possibility of a set back for markets in the near term.  This latter view doesn’t contradict the above long term view.  Tactically we can be less optimistic, expecting a sell-off, while strategically holding a bullish long-term view.  markets, remember, don’t travel in straight lines.

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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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