Shutdown Ends but Economic Questions Persist

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Since the government shutdown began at the beginning of October, a lack of data has contributed to uncertainty about the state of the U.S. economy. The data we have gotten over the past month and a half points to the persistence of heightened inflation and a weakening labor market—an unusual combination that we’ve covered in detail in recent weekly commentaries. Inflation appears to be hovering around 3 percent, above the Fed’s 2 percent goal, while hiring numbers remain tepid and job cuts are on the rise.

Now that the shutdown is over, the usual data will return, potentially bringing more clarity to the economic picture. The timing is propitious, with the Federal Reserve meeting December 9–10 to decide whether to lower interest rates for the third consecutive time.

Despite continued labor market weakness, investors are pricing in only a 43 percent chance of a rate cut in December, down from over 100 percent on October 24 and 66 percent a week ago. This decline is partly due to recent public comments from committee members. For example, Atlanta Fed Chief Raphael Bostic recently suggested that labor market weakness may be a result of structural changes, such as lower immigration and the widespread adoption of AI, which wouldn’t be affected by lower interest rates. Cleveland Fed Chief Beth Hammack, Boston Fed Chief Susan Collins and Minneapolis Fed Chief Neel Kashkari agreed that the central bank should hold rates steady to reduce inflation. These remarks add weight to Fed Chair Jerome Powell’s October 29 comment that a rate reduction was “not a foregone conclusion—far from it.”

Lower- and middle-income consumers have much at stake in the Fed’s decision, since these groups have felt the brunt of the impact from high interest rates and a weak labor market. We can see this dynamic playing out in recent data from the National Association of Realtors (NAR), which reported that the median age of first-time homebuyers climbed to an all-time high of 40 years old, up from 33 in 2021 and 29 in 1981. Meanwhile, new home buyers now account for just 21 percent of the housing market, the lowest portion since the NAR began collecting data in 1981. The median house price is now $415,200, up more than 50 percent since 2019.

Data released last week underscores the challenges faced by lower-income consumers. Fitch Ratings announced that the share of subprime borrowers at least 60 days late on their auto loans rose to 6.65 percent, the highest since the agency started collecting data in 1994. Transunion noted that the share of consumers taking on subprime loans reached 14.4 percent in the third quarter, up from 13.9 percent last year and the highest since 2019. And the latest ADP jobs report shows private employers shedding an average of 11,250 jobs per week for the four-week period through Oct 25.

These numbers paint a portrait of everyday consumers that contrasts starkly with the situation of higher-end consumers, many of whom have comfortable savings, fixed-rate mortgages on houses that have appreciated in value and substantial equity holdings.

In general, equities have produced impressive returns this year, and companies in the S&P 500 appear set to record a fourth straight quarter of double-digit earnings growth. While stock gains have benefited many households—Americans now invest more money in equities than ever before—a potential downturn could have serious ripple effects throughout the economy. Markets have shown slight signs of unsteadiness recently, with the Bloomberg Magnificent Seven stock index falling 4.8% from the all-time high it set on October 29. Whether a downturn will materialize is impossible to predict, but it’s equally impossible to ignore growing concern about the long-term viability of the AI boom.

There is a simple answer to worries that AI-driven stocks may be overinflated: Hold a diversified portfolio that’s not concentrated in tech or any other sector. Overconcentration can introduce extreme risk. Consider the case of tech company Cisco. Cisco played a central role in the dot-com buildout of the late 1990s, propelling its stock to a high of $80 on March 27, 2000. When the bubble burst, its share price had plummeted to $8.60 by October 8, 2002. Last week, strong earnings boosted Cisco stock to $78—finally approaching its peak from 25 years ago.

Diversification with a long-term perspective was a winning strategy in the wake of the dot-com bubble in the early 2000s, and we believe it will be a winning strategy if it turns out we’re in an AI bubble today.

Wall Street wrap

Small business optimism declines amid a weak labor market: Optimism among small businesses dropped for the second straight month, falling from 98.8 to 98.2 according to the latest data from the National Federation of Independent Business (NFIB). This number is still above the 52-year average of 98.

A seasonally adjusted 32 percent of business owners reported job openings they could not fill in the current month, the same percentage as in the previous month. Before August, the last time unfilled job openings reached 32 percent was December 2020. Additionally, 27 percent of owners cited labor quality as their single most important problem.

“Optimism among small businesses declined slightly in October as owners report[ed] lower sales and reduced profits,” said NFIB Chief Economist Bill Dunkelberg. “Additionally, many firms are still navigating a labor shortage and want to hire but are having difficulty doing so, with labor quality being the top issue for Main Street.”

Just over a quarter of business owners (26 percent, seasonally adjusted) reported raising compensation in October, down from 31 percent in September. A seasonally adjusted 19 percent plan to raise compensation in the next three months.

A net negative 13 percent (seasonally adjusted) of all owners reported higher nominal sales in the past three months, down seven points from September, while reports of positive profit trends fell nine points to -25 percent. Both figures are historically depressed.

The report showed some positive signs regarding inflation. The net percentage of owners raising average selling prices fell three points from September to a seasonally adjusted 21 percent, and a seasonally adjusted 30 percent plan to increase prices, down one point from September. Despite these declines, price increases remained above the monthly average of 13 percent, pointing toward the persistence of elevated inflation.

The week ahead

Wednesday: The Federal Reserve will release minutes from the October 29 Federal Open Market Committee (FOMC) meeting. We will be looking through the debate around the October rate cut for clues about what may unfold in December as FOMC members try to balance heightened inflation against growing signs that the labor market is weakening.

Nvidia will report earnings Wednesday as well. Investors will be parsing the AI juggernaut’s comments for clues about the likely direction of AI-related spending.

Thursday: The Bureau of Labor Statistics will release its delayed September jobs report. Investors will be looking for insight into the direction of the labor market after private indicators have shown the jobs picture weakening. The four government reports prior to September averaged just 27,000 net new jobs, with August at 22,000.

Friday: Standard & Poor’s will release its preliminary Global U.S. Manufacturing and Services Purchasing Managers Index. Both were in expansion territory in October. That said, both manufacturing and service sector firms reported difficulties passing higher costs on to customers, due to subdued demand and intense competition, and business confidence last month for the year ahead neared its lowest levels in the past three years.

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