Economic data is cloudy as to the health of the economy and though 99% of CEOs expect an economic downturn, half think it will be mild in the US according to Ernst Young ’23 survey. This outlook is shared by most public company CFOs as they expect only a mild recession in 2023, according to Deloitte’s 1st Quarter ’23 CFO Signals survey. CFOs say they expect revenue & earnings growth, and capital investment to rise modestly driven by acquisitions, divestitures, and joint ventures in new markets which most all say they are considering. The top concerns of companies according to the surveys are persistent Inflation which they expect to average 4-6% throughout 2023, supply chain disruptions exacerbated by geopolitical tensions particularly with China, and talent shortages. Economic data are mixed, but flashing Yellow as supply chains adjust post COVID-19 and suppliers work to reduce inventory. According to the April Institute of Supply Management (ISM) surveys:

The takeaway is that the US economy is slowly contracting and because the US economy runs on Automobile, Credit Card, and Mortgage credit, the Fed’s interest rate hikes are sure to contract credit as banks hunker down to pay more to keep deposits and to right-size their underwater loan portfolios by charging more on refinanced loans.

Yet concurrent with the bank solvency problems, commercial real estate is heading for a cyclical downturn. Already there have been defaults by PIMCO, Blackstone, and Brookfield Partners heretofore investment grade credits. According to Goldman Sachs, small to mid-sized banks hold 80% of all commercial real estate loans (CREL). The big 4 banks (JPMorgan, Bank of America, Citi Corp & Wells Fargo) don’t have worrisome exposure to commercial real estate.

Like the saying “when it rains it pours,” our economy may be facing a thunderstorm as Congress needs to reach a comprise agreement to raise the Debt limit that Treasury Secretary Yellen says is now needed by June 1. That ceiling will need to take us through January 2025 and must raise the debt limit to $35 trillion by our estimates considering the already agreed to spending and our deficit spending to get us through the 2024 elections.

Meanwhile international reports show “de-dollarization” is underway which as we have suggested before limits the Fed’s ability to lower interest rates if the US is going to attract Treasury purchasers and stand up the dollar against challengers. This puts pressure on growth when much of it is fueled by lending, so our view is we will see targeted monetary and fiscal measures to support our ailing economy. Remember, Congress needs do nothing to increase tax rates by 3-4% due to the 2025 sunset provision in the Trump tax cut. Perhaps then Congress will extend the income tax cut and lower the Estate and Gift tax exclusion from the $26,170,200 for married couples and $14,197,333 for individuals in 2024 back to some amount above $5.49 million per individual where it will revert without intervention.

Other monetary measures to aid the economy may be price and yield curve controls with a twist as Japan is using to keep interest rates at a fixed level while supporting their currency. OR perhaps Treasury may Cont’d Page 2 add an incentive bonus provision to bond purchases whereby purchasers receive lower than 5.0% interest plus 10-15% of the upside appreciation of gold during the term the bond is held. Whatever the decision on our policy actions, regardless US spending must moderate to match income receipts. And until the turmoil settles interest rates will surely go a bit higher (5.0%-5.50%), stay there longer, and bring some pain particularly to the over-leveraged.

In such an economic environment the potential spillover effect almost certainly will affect additional banks and may hit some insurance companies as they likewise invest in government bonds and real estate loans which have deflated market values due to the Fed’s aggressive rate hikes which have lowered their reserves.

In conclusion, we expect continued market volatility for the rest of 2023 through 2024 which is both a threat and opportunity. We know the higher the price paid for an investment the less return earned, and stocks are still not cheap by historical metrics. This causes us to remain cautious and be patient keeping some “dry powder” to use when more favorable prices arrive. That said, we continue to maintain positions in Microsoft, Apple and some other solid tech shares as they are great companies, but even so we are hedged because they are overvalued and facing economic obstacles to growth.

Our portfolio asset allocations reflect our adherence to three financial principles: (1) keep investment costs low, (2) invest in the best reward-for-risk opportunities, (3) and pro-actively combat risks to protect principal. Volatility we are experiencing is tied to continued supply problems, export disadvantage from a strong dollar, slower growth from less lending, and fallout from geo-political military and economic events underway. Please remember, a $1.0 million account that falls 50% to $500,000 requires a 100% return to get back even. Those who say, if you don’t stay invested you could miss the best 10 days of a market rebound, don’t tell you that missing the worst ten days will make you way better off.

Thank you for your trust and confidence. Enjoy your summer as we are Watching Your Money as if it were ours!