Written by Steve Wyett, BOK Financial’s Chief Investment Strategist
How do recent changes in the U.S. economy, such as shifts in interest rates or government policies, affect consumer confidence and spending behavior? How might these changes ripple through the stock market’s performance?
Changes in the economy have differing effects on consumers and businesses. As an example, how one feels about higher interest rates may be based on whether they are a borrower or a saver. For those individuals and companies where debt is not a factor, higher interest rates have had a positive impact on incomes. For corporations, treasurers’ cash management means something again as the ability to earn money on cash balance returns. However, in general, the U.S. economy is based on credit, so higher interest rates normally slow economic activity, reduce corporate profits, and lead to somewhat higher unemployment. As these occur, we normally see inflation decline, which is why the Fed raises rates to slow inflation. It also explains why the Fed lowers rates to spur economic activity. From a government policy standpoint, also known as fiscal policy, the impacts can be even more powerful. During the pandemic, the Federal government injected some $6 trillion dollars into the economy. The effect of this was to avoid a prolonged economic decline, but the level of support also spurred inflationary pressures. At present, the government continues to spend far more than annual revenues, which is additive to growth in the short run, but ongoing deficits have accumulated to over $34 trillion in outstanding debt. This level of debt has become much more expensive to service as the Fed has raised rates, and while not at crisis levels, some shift in the direction of fiscal policies would seem prudent. How the markets react to the above is based on the direction of inflation and the overall level of economic activity and corporate profits.
With emerging economic trends, which industries do you predict will see growth in job opportunities? Conversely, which sectors might encounter challenges due to changing market dynamics or technological advancements?
The pandemic laid bare the risks of having so much production overseas. Companies were unable to access goods, and those that were produced got caught in a tangled supply chain. The result has been a move towards a less globalized economy. Terms like on-shoring, near-shoring, and friend-shoring describe a shift in how companies are investing capital to have greater control over both production and distribution. This has led to an explosion of spending on manufacturing facilities. In the last six months, we have also seen Mexico overtake China as the source of most imports into the U.S. in addition, national security concerns have led to direct fiscal policies to move manufacturing of some items, like micro-chips, into the U.S. This is going to be an ongoing trend which could mean real opportunities for individuals and companies with skills sets like HVAC, construction, welding, and other basic skills. Technology has been an ongoing factor within our economy for years and, overall, greatly additive to our growth and productivity. The current trend of artificial intelligence, AI, holds similar or potentially even more promise. However, as opposed to past technological advances, which tended to impact lower-skilled jobs the most, AI’s impact could be much different. Recent early studies by the Fed indicate that up to 90% of AI’s impact could be on the top 10% of wage earners. It is too early to know for sure, but virtually every company should be working to understand how AI can be a tool…or risk missing a significant change coming our way.
What strategies do you recommend for businesses to remain agile and resilient in the current economic landscape marked by volatility and uncertainty? How can companies effectively pivot their operations to adapt to changing market conditions?
The ingenuity of U.S. companies in the face of change is a key reason why the domestic economy has far outperformed its global peers. We can see this in the data on stock market performance and the equity value of domestic companies versus global equities. However, as opposed to the last 15 years, when interest rates were at or near zero, we are now in an environment where balance sheet management is of much greater importance. We do not expect a return to the ultra-low interest rate environment that characterized the period from the end of the financial crisis in 2009 through the resurgence of inflation in 2022. We expect the longer rates stay higher, the greater the divergence in performance we will see between those companies who maintained a risk-controlled process on debt and those who did not. When rates are very low, the cost of making a bad capital decision is reduced. Higher rates increase these costs, so our advice would be to do everything possible to make sure debt levels are manageable at current rates and to not count on lower rates going forward. This can mean the total revenue of the business across not only spending but also areas like backlogs to make sure current and future business remains profitable. It is impossible to insulate ourselves against every possible outcome, but we do have things we can control. Additionally, periods of volatility, uncertainty, and economic stress can be fantastic periods for companies that manage risk to make decisions that can produce higher future growth. In short, one company’s distress is another company’s opportunity. This is a period where strong relationships with your financial partner can pay huge dividends. For many companies, a review of their history reveals the biggest opportunities came during times of stress.
For entrepreneurs and business owners, what are some essential principles of financial planning and risk management to navigate the fluctuations in the economy? How can they mitigate risks while still pursuing growth opportunities?
Businesses today need to understand and plan for a different interest rate environment going forward. Capital is going to have a higher cost going forward. And frankly, that is not all bad. When the cost of capital is low, we see individuals and companies making decisions that might seem a bit imprudent. This is particularly true for individuals and companies who have been through a business cycle or two. The difficult part of the ultra-low rate cycle we were in was that it lasted so long. This forced almost all of us to act a bit differently, and some risk management practices looked less relevant. That changed quickly as the Fed embarked on its fastest and most meaningful rate hiking cycle in history. A higher cost of capital enforces some measure of discipline in the market, which can improve the capital allocation process. Yes, it might slow things down a bit, but the projects that are done are more viable and, therefore, more valuable over the long run. As entrepreneurs and business owners navigate this environment, it can begin with building a little more room for error in assumptions. This might risk losing a project bid or two, but avoiding mistakes is part of success. I would re-iterate the importance of a strong relationship with a strong financial partner.
Drawing from historical data, what insights can we glean about the relationship between election outcomes and economic performance in the short and long term? Are there any patterns or correlations that business leaders should consider when planning for the future amidst electoral transitions?
Since 2024 is an election year, and one that might be different than anything we have seen in the past, this topic comes up in every presentation I make. And without dismissing the broad variance of the policies and platforms between candidates, the longer-term data shows elections are not that impactful. When it comes down to it, the underlying basis for the growth of our economy and markets is based upon the ability of individuals and companies to have the best chance of success relative to the rest of the world. And on that scorecard, we are still the best game in town by a large margin. Does this mean we should not care about elections? I am not saying that in the least, and I hope everyone lets their voice be heard at the polls. However, the ability to enact huge shifts in policies is limited by the close division within our country. Put another way, gridlock resists much change. We have some real issues with which we need to face. Our fiscal position is going in the wrong direction. We are not talking about failure, but we are going to be limiting our future success. We need a cogent and workable immigration policy. When thinking about labor as a raw material for output, we need more of it than we are producing organically. Economic growth going forward is going to be of vital importance as we consider how we get our fiscal position on a more sustainable path. A comprehensive review of our entitlement programs is warranted, too. They represent some 60% of our annual budget, are mandatory, and are indexed to inflation. The reality is that these issues are not partisan in nature. They are economic and math-based. Beyond that, our economy is filled with people who get up every day and think about ways they can meet the needs of their customers better. People who think about new ways to solve problems and deliver value to their clients. People who are driven by making us better. From that perspective, we remain incredibly optimistic about the future. This is the greatest country in the world, and the best is yet to come.
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