2023 is in the rearview mirror. It seems time tends to speed up the older you get. This is one of life’s little tricks, as is giving you children when you are young, naïve and unable to afford them. Of course, I am well past all of that now. However, I am still waiting on the wisdom, which is supposed to come with age, to arrive.
After all, it seems a lot of unwritten rules, societal norms, historical correlations and the way things are supposed to work have changed over the last several years. Shoot, they have flown out the window. So much so, old timers, like yours truly, are learning the ‘new normal’ at the same time as all of these whippersnappers.
You read that right. I wrote whippersnappers. And, yes, I am being somewhat hyperbolic.
After all, there are just some things which are simply inherent. The sun rises in the East. When the yield curve inverts and banks’ net interest margins compress, they extend fewer loans. When this happens, the growth in the money supply slows. As the amount of money sloshing about the economy stagnates or contracts, business owners and consumers tighten their belts. Obviously, this should lead to slower economic growth, right?
As Lee Corso might say: “not so fast my friend.”
While that paragraph is basically, and intuitively, the way things should happen, it doesn’t mean they always do or will. 2023 was one of those times when everything I described occurred, but businesses and consumers continued to spend and invest, almost in spite of themselves. As a result, the US economy was much stronger than just about anyone thought it would be at the beginning of the year.
I mean, weren’t a lot of people wringing their hands and gnashing their teeth about inflation, the Federal Reserve and the prospects for a recession, perhaps a significant one, this time last year? Didn’t we enter last January more gloomy than ebullient, which was completely understandable after 2022’s disastrous market results?
So much so, you would have been excused for believing the proverbial sky had fallen when Silicon Valley Bank, and others, collapsed this past March. ‘Here we go again,’ seemed to be the general sentiment, and everyone on the television seemed to have a bunker mental. Shoot, it was time to stock up on gold, ramen, bottled water and ammunition.
And then it wasn’t.
Cooler heads prevailed, and the business of America got back to doing business. Make no bones about it. Despite all of the obstacles, headwinds and reasons to the contrary, that was the prevailing theme in 2023: the business of America got back to doing business. To be sure, there was a lot of belly-aching about the higher cost of money, inflation, and a host of other perceived ills. However, when push came to shove, companies will still adding jobs and looking to add more.
If only they could find the workers. Specifically, the somewhat trained workers who could pass a drug test, and where willing to work the necessary hours at a wage the employer wanted to pay. Where were these unicorns? Inquiring minds wanted, needed, to know.
This is important, because money speaks louder than words. It always has. That is unless you are scared of being ‘cancelled’ on social media by people who pretend to be offended by innocuousness. That seems to be sort of a generational thing. After all, the older you get, the more you can claim ignorance as to what passes for probity in today’s society.
Trust me on that. I digress.
As a general rule of thumb, companies don’t add to their headcount when business is tough or when they expect it to be so. After all, the CFO’s office can control expenses a lot more easily than they can revenue, if you catch my drift. Therefore, you can surmise business is okay, even when it shouldn’t be, when the economy, in aggregate, is creating jobs.
While some might argue job creation is a lagging indicator, since employers tend to be more reactive to business conditions than proactive, there is a simple truth. The US economy is heavily, and I mean dump trucks of cement heavy, reliant on consumer spending. When companies add workers, they create paychecks, which, in turn, create brand new American consumers. Intuitively, the more consumers a consumer driven economy has, well, the better.
Voila. 2023 in a nutshell. Despite, which should be the word for the year, everything which would have suggested overall economic sluggishness this past year, companies continued to add to their payrolls. This spurred personal consumption expenditures which required adjustments to inventories and a whole host of other virtuous economic activities.
At least officially and in aggregate. Things might be drastically different depending on where you live and what you do, or used to do, for a living.
As I have written here in this column, blog or newsletter, the biggest fallout from the wobble in the financial system this past Spring will be on smaller banks. You can think of them of ‘non-systemically important financial institutions’ in a national sense. They have names like First State Bank of Dogpatch, well maybe not, and them are indeed systemically important to the small towns and areas they serve.
Micropolitan and rural areas are littered with smaller firms which are struggling with their capital due to decreased market values in their fixed income portfolios. Since bond prices and interest rates move in opposite directions, the increase in rates over the couple of years has put a whammy on smaller banks with bigger (relatively speaking) bond portfolios.
It is simple Accounting 101. When your assets decrease and your liabilities stay the same, your equity declines. Since banks make loans based on the amount of equity they have, underwater bond portfolios (read assets) have a depressing impact on the extension of credit. When that happens, local economies suffer.
I saw this first hand a couple of weeks ago on a trip to Alabama’s Gulf Coast to meet some clients. In smaller towns like Clanton, Greenville, Enterprise and others, there were a lot more empty storefronts, abandoned gas stations and shuttered restaurants than there were this time last year. Shoot, this time 6-months ago. While it wasn’t necessarily an economic Armageddon in any of these places, it was very noticeable. The faded signs and the empty parking lots which weren’t there not so long ago, and not just in one location.
This will be a theme in next year’s election campaigns: the widening economic gap between our rural and urban areas. The inability of many smaller banks to make loans in these ‘out of the way’ places, which the bigger, healthier firms eschew, has exacerbated a long-standing problem. It very easily could come to a head over the next several years, as many of these small lenders consolidate to stay alive. This could mean the one lender in many of these areas closes its doors.
Expect this to a major story moving forward.
In the end, despite the downer I just gave you, 2023 was a surprisingly strong for the US economy and stock markets as a whole. Businesses and investors made more money than anyone would have thought possibly this past January. This despite a lot of economic headwinds and data which historically would have suggested slower growth.
Hey, I suppose people and businesses can change the way they respond to economic conditions. There is nothing that says you have to always do this when that happens. As a result, doing what I do for a living is often equal parts understanding history and the willingness to learn.
The best part for me? I am not sure they teach history to these whippersnappers any longer.
Happy New Year!
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
John Norris
Chief Economist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.