FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
July 11, 2023

IN THIS ISSUE:

1. Overview – What We’ll Talk About Today

2. Stocks Deliver Impressive Returns Despite Several Hurdles

3. Recession In 2023? – Why The Bears Have Been Wrong

4. Office Building Vacancy Rate Hits New Record High

Overview – What We’ll Talk About Today

I think it would be safe to say at this point that US equities have outperformed most forecasts for this year and have exceeded most investors’ expectations. As of last Friday’s close, the S&P 500 Index had gained almost 16% for the year. That’s pretty impressive given that most forecasters have been predicting a recession just ahead, and consumers seem to be in a dour mood about things in general.

Today we’ll look at how the equity markets have performed this year and speculate whether this impressive performance can continue. I suspect many of you reading this have your doubts, but I think most of us can agree that stocks have outperformed expectations so far in 2023.

Following that discussion, I’ll offer a few thoughts on why so many forecasters are so negative in their outlooks for the balance of 2023 and, in some cases, beyond. For many of these people, it is just their nature to be negative, no matter the circumstances. Never mind that they are usually wrong – that doesn’t seem to matter.

Finally, we’ll revisit the problem of rising office building vacancies. According to the National Association of Realtors, the US office vacancy rate hit a new record high in the first quarter of this year. If this trend continues, it poses a real threat to the US economy.

Let’s get started.

Stocks Deliver Impressive Returns Despite Several Hurdles

As noted above, the Standard & Poor’s 500 Index has gained 14.6% this year as of last Friday’s close. The Nasdaq 100 Index is up a whopping 37.5% so far this year. The Dow Jones Industrial Index, on the other hand, has been a laggard in 2023, up only 1.8% as of last Friday.

It is true that most of the equity market gains this year have come from just a handful of big-name stocks – Apple, Microsoft, Nvidia, Amazon and a few others. Without their impressive gains, the stock market would be flat on the year.

In 2023 through May, the top 10 stocks were responsible for 9.3 percentage points, or 97% of the US market’s overall gain. Of those top 10 stocks, Nvidia was by far and away the best performer, gaining 189.5% in the first half of this year – the stock’s best performance in the first half of any year since the company went public in January 1999.

2023 has seen the best first-half performance for the Morningstar US Technology, Communication Services, and Consumer Cyclical Indexes in their entire tracked histories (since 1999).

In June, the Morningstar US Market Index finally crossed into bull territory – up more than 20% from its most recent low – after 2022′s abysmal bear market. By that measure, a 20+% bounce off the lows, we are officially back in a bull market – for whatever that’s worth. 

This year’s impressive stock market gains have come even as several obstacles stood in the way. The most obvious being the fact that the Federal Reserve has raised short-term interest rates 10 times since this rate hiking cycle began in March of last year – with the likelihood of another rate increase at its next meeting on July 25-26.

While the Fed paused and left its key interest rate unchanged at its June meeting, it is widely expected the Fed will raise rates at least two more times this year in its quest to get inflation under control. The latest minutes from the June Fed policy meeting made that abundantly clear.

Some Fed-watchers believe there will only be one more rate hike this year by the central bank. I don’t buy that view. I don’t believe Fed Chairman Jerome Powell buys that view either – especially if he is really serious about getting inflation down – and I believe he is.

While the upcoming Fed rate hikes are widely expected, it will be interesting to see if the equity markets can continue to post gains over the next few months. We’ll see.

Recession In 2023? – Why The Bears Have Been Wrong

As I have reported often this year, most forecasters have been predicting a recession in the last half of 2023. As regular readers know, I have not joined this bearish chorus and, in fact, I have argued that a recession in late 2023 is NOT the most likely scenario.

Now here we are in the second half of the year, and there are still no compelling reasons to believe a recession is about to unfold. The economy, while not going gangbusters, continues to grow. As noted above, the Fed has raised short-term interest rates 10 times, and yet the economy continues to expand. Consumer spending, which is the main driver of the economy, has slowed somewhat in recent months, but the economy remains in positive territory.

All in all, I don’t think we could have expected the economy to perform any better than it has. Put differently, this economy still looks pretty good to me.

The question is: Why have most forecasters been so bearish in their predictions?

The reasons vary, of course, but here are the main worries most forecasters have pointed to this year. First, it was the spike in food and energy prices which sent inflation soaring and the Consumer Price Index spiked to above 9% briefly last year.

Then it was the housing market which saw mortgage rates jump from 5% to above 7%. And now it’s concerns about the Fed raising rates too high and sending the economy into recession. In case you haven’t noticed, it’s always something with these pessimists who continually expect the worst. And they’ve always been around – this is nothing new.

On a personal note, I can identify with the pessimists’ point of view because I used to be one. When I first started my career over 40 years ago, I found the pessimists arguments quite compelling and, frankly, more interesting than the optimists’ arguments.

But it didn’t take me very long to figure out that the pessimists are usually WRONG. Good things happen much more often than bad things, at least in this country. The economy grows; business thrives; progress happens; the standard of living increases; healthcare gets better and better. I could go on and on.

Don’t get me wrong. I’m not wearing rose-colored glasses and see only the good things. There are plenty of bad things happening in the world, including in this country. But in the long-run, I believe good things prevail over bad things.

Be that as it may, the pessimists maintain their arguments and we should not expect that to change. While it’s still too early in the year to say for sure, I continue to believe there is a good chance we avoid a recession this year.

Now let’s move on to the biggest threat I see to the economy later this year.

Office Building Vacancy Rate Hits New Record High

As I have argued all year, I don’t believe a recession in the second half of 2023 is the most likely scenario. While consumer spending – which makes up almost 70% of the economy – has softened recently, I still believe it will be enough to keep us out of a full-blown recession.

What is increasingly worrying me is the fact that office building vacancies continue to rise. According to the latest report from the National Association of Realtors (NAR), the US office vacancy rate hit a new record high in the first quarter of this year.

The office vacancy rate rose to a record high of 12.9% in the first quarter from 12% a year ago, representing 72.9 million more square feet available to lease. 

"The future of the traditional office space is unclear due to the ongoing impact of COVID-19, with many businesses adopting hybrid work arrangements that allow for a mix of in-person and remote work," NAR wrote in the report that was released earlier this year.

Class A offices - high-value properties that usually have above-average rent – had a vacancy rate of 17.9% in the first quarter. Houston, Dallas-Fort Worth and San Francisco led the office vacancy rise. It remains to be seen if this disturbing trend continued in the 2Q but it almost certainly did.

National Public Radio (NPR) reported that nearly 20% of office spaces were vacant at the beginning of May.

Fortunately, not all the news is bad as some regions saw improvement. San Jose, Atlanta and Miami had the highest net absorption, with 1 million more square feet leased than left vacant over the course of a year. 

NAR also reported that an increasing number of universities are considering leasing office spaces as a way to expand their facilities and bring more students back into classrooms.

Other areas of commercial real estate had lower vacancy rates, especially in retail and industrial properties. That's as consumer demand remains strong, while the need for storage space hasn't eased.

So while the office space vacancy problem is a serious threat to the economy, especially if it continues, it could be worse. I’ll leave it there for today.

Very best regards,

Gary D. Halbert

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Economic & Market Outlook – Still No Recession

 

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