Looking ahead to the medium term, I identify two key challenges:
The phrase "locked in" has emerged as a pivotal force, not only bolstering the housing market but also exerting a positive influence on the stock market. Notably, 42% of Americans are currently free of mortgages, while an impressive 92% of mortgage holders have secured rates below 6%. This, coupled with the absence of student loan payments, has significantly contributed to the ongoing strength of the consumer. However, an alternative perspective on the concept of rate locking emerges. While locking in rates at lower levels is favorable for consumer balance sheets, it presents distinct challenges for lenders, encompassing the banking sector and the Federal Reserve. This raises the question of when bank balance sheets might witness improvement. In a high-rate environment, such improvement may come at the expense of damaging borrower balance sheets. My observation is that bank balance sheets are likely to commence an upward trajectory after 2025, particularly as a substantial portion of high-yield debt matures within that timeframe. This challenge holds implications for the present and the future, as a dearth of new debt supply can lead to a sluggish growth rate.
The disinflationary trend observed thus far (from 9.1% to 3.2%) signifies a departure from deflation, thereby supporting the resilience of profit margins. Analyzing the average monthly increase in the Consumer Price Index (CPI) from January 2023 to July 2023, a projection of 4% CPI by December emerges. Concurrently, the real 10-year rate stands at 1.6%. If this rate remains stable, the 10-year rate could potentially approach 5.5%. This dynamic raises a compelling question: How will equities fare against the risk-free rate? In this scenario, a choice between locking in a 5.5% return for a decade or embracing the risk for a potentially higher 9% return arises. I am inclined toward the latter choice, envisioning a best-case scenario of a 9% return. Considering our current valuations, a 5% projection appears optimistic in light of prevailing conditions.