Crawford Economic & Market Environment (Slides)

The Firm's Outlook: Summary and Conclusion

The Economy

The U.S. economy continues to grow steadily, driven by consumption. Real Gross Domestic Product (GDP) growth should be around 2% for 2024.
Unemployment has been rising slowly over the past year from its low point of 3.4% to its current level of 4.2%. The Federal Reserve (Fed) projects 4.4% unemployment by year end, acknowledging that labor market conditions have softened.
Inflation continues to decline. The Personal Consumption Expenditures (PCE) Price Index is now at 2.2% year-over-year, fairly close to the Fed’s 2% target. PCE core is now 2.7% year-over-year, and also trending lower.
The Fed has begun a monetary easing cycle which will reduce short-term interest rates across the board. Long-term rates have already declined significantly in anticipation of Fed reductions.
The U.S. economy is in reasonably good shape but is showing some signs of weakening. A soft landing is widely accepted as an outcome, although history would suggest caution on this assumption.

Stocks & Bonds

Common stocks are enjoying a very strong year. From extreme concentration in a few dominant companies, the market has broadened out. This is a positive development.
After high returns in 2023 and thus far in 2024, stocks are not cheap. Investor confidence remains very high.
Cash holdings among investors are high, representing potential demand for stocks and bonds.
Bond yields declined significantly in the third quarter. Investors were discounting the Fed’s monetary pivot and evidencing concern about a weakening labor market.
The outlook is clear for short-term interest rates: lower as the Fed moves forward with its easing policy.
The extended outlook for longer-term rates is less clear, but with labor conditions softening and the Fed easing, the path of least resistance is lower.

The Fed Pivots in a Big Way

After raising and holding the federal funds rate for more than two years, the Fed made a dramatic pivot by reducing the rate by 50 basis points. Most observers expected only 25 basis points.
We assume the Fed was motivated by two factors. One, their confidence is improving that the inflation target of 2% is well within sight. Two, they are concerned about weakening conditions in the labor market and hope to head off further deterioration in employment.
Two more cuts have been signaled for this year and four more for next year. If realized, federal funds will be at 3.4% at the end of 2025.
We are now definitely on the other side of monetary policy and short-term interest rates are headed lower.

Why Cut Now? Lower Inflation Gives the Fed the Go-Ahead

The two most important inflation measures are the Personal Consumption Expenditures (PCE) Price Index and the Consumer Price Index (CPI). The PCE Index is the Fed’s favorite measure.
PCE is now at 2.2% year-over-year and trending toward the target of 2%. The Fed believes this is close enough to get started on the other side of their mandate. Core PCE is at 2.7% year-over-year, but also trending lower.
We believe the achievement of the target of 2% inflation is of utmost importance. Sustainable low inflation will make it possible for other economic elements to function in a neutral fashion.
The Fed is seeking to achieve a soft landing for the economy. 2% inflation will enhance their chances.

Why Cut Now? The Labor Market is Softening

The Fed is shifting its emphasis from fighting inflation to supporting employment. Why

Unemployment has been slowly but steadily increasing since last year from 3.4% to 4.2%.
The amount of new jobs being created has been slowing for some time, especially as measured on a three month average.
The ratio of job openings to unemployment keeps narrowing. When these data points cross, unemployment usually begins rising faster.
Rising unemployment threatens consumption, the driving force in our economy. As people either lose their job or fear losing it, they may reduce spending. This process can spiral into a recession.

Strength in Consumption is the Key to U.S. Economic Growth

Ours is a consumption driven economy. Over 70% of GDP comes from consumption.
Notice above how important consumption has been to the economy. It is fair to say “as consumption goes, so goes the economy.”
If consumption is threatened, the Fed is ready to come to the rescue. Their recent and aggressive pivot on monetary policy is evidence of such.

Savings and Spending: The Risk to Consumption

Recent upward revisions to the savings rate have it now at 4.8% This indicates more spending power by the consumer than previously expected. This is good news.
Nevertheless, if the savings rate stabilizes or declines, it will likely mean less consumption.
Below, note the trends in income and personal consumption.
A higher rate of spending growth over income growth places pressure on spending at some point.
Consumer spending has been a tailwind for economic growth since the pandemic but could turn into a headwind, implying slower growth in the economy.

A Soft Landing is More Likely, But...

The soft landing scenario for the economy is widely accepted and heartily endorsed by investors.
Investors should not forget that there are still some warning signs that have the potential to disrupt the soft landing scenario. Notice the charts.
- In the past, when the Fed has begun cutting interest rates, recessions have occurred relatively soon thereafter.
- Inverted yield curves have long been considered as recession warning signs. However, the riskier period occurs when inverted yield curves revert to positive. The 2-Year / 10-Year curve has recently flipped to positive.
We are not predicting a recession. But neither do we consider it wise to ignore these two indicators.

The Natural Rate of Interest and the Bond Market

The natural rate of interest is a theoretical rate. It is assumed to be the real interest rate that allows the economy to be at full employment without causing inflation to rise or fall.

We present a blank picture to illustrate the fact that no one knows what the natural rate of interest is.
Currently, the Fed assumes the natural rate to be 2.9%. This is up from 2.5% pre-pandemic. Their view is important because it informs monetary policy. Federal funds above 2.9% are assumed to be restrictive, below 2.9%, stimulative.
Recent developments may have altered the savings/investment ratio to suggest a higher natural rate.
- Investment in AI and green energy
- Very large budget deficits and growing government debt
- The wealth effort from housing and stock values

If the natural rate is higher than currently assumed, higher short and long-term interest rates could be required in the future.

Owners of Stocks and Houses are Doing Very Well

The stock market is doing very well, regularly hitting new all time high levels. House prices are also hitting all time high levels. The combination of elevated stock and home prices is creating a strong wealth effect.
Increasing wealth is a firm foundation for consumption growth.
With both categories elevated in price, investor expectations for further appreciation should be tempered.

An Economic Soft Landing? The Fed Believes

Economic Projections of the Federal Reserve Board of Governors – September 2024

The Fed believes it is on a path to a near perfect soft landing.
They project that by year-end 2025 the economy will be very close to equal balance between economic growth, unemployment, inflation, and interest rates.
We wish the Fed well and are hoping a soft landing occurs but acknowledge that history is not on their side.
There are economic circumstances that suggest this time may be different. We shall see.

Disclosure statement

Crawford Investment Counsel (“Crawford”) is an independent investment adviser registered under the Investment Advisers Act of 1940, as amended. Registration does not imply a certain level of skill or training. More information about Crawford, including our investment strategies, fees, and objectives, can be found in our Form ADV Part 2and/or Form CRS, which is available upon request.

This material is distributed for informational purposes only. The statements contained herein reflect opinions, estimates and projections of Crawford as of the date hereof, and are subject to change without notice. This material is not financial advice or an offer to sell any product.

Forecasts, estimates, and certain information contained in this commentary are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Any projections herein are provided by Crawford as an indicator of the direction Crawford’s professional staff believes the markets will move, but Crawford makes no representation such projections will come to pass. Crawford makes every effort to ensure the contents have been compiled or derived from sources believed reliable, and contain information and opinions that are accurate and complete; however, Crawford makes no representation or warranty, express or implied, in respect thereof; takes no responsibility for any errors that may be contained herein or omissions; and accepts no liability whatsoever for any loss arising from any use of or reliance on this report or its contents. Crawford reserves the right to modify its current investment strategies and techniques based on changing market dynamics or individual portfolio needs.

Forward-looking statements cannot be guaranteed. This document may contain certain information that constitutes “forward-looking statements” which can be identified by the use of forward-looking terminology such as “may,” “expect,” “will,” “hope,” “forecast,” “intend,” “target,” “believe,” and/or comparable terminology. No assurance, representation, or warranty is made by any person that any of Crawford’s assumptions, expectations, objectives, and/or goals will be achieved. Nothing contained in this document may be relied upon as a guarantee, promise, assurance, or representation as to the future.

Economic and Market Environment

Fourth Quarter 2024