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Gitterman February Macro Commentary: Expectations Meet Reality

The first FOMC meeting of 2023 on February 1st didn’t deliver any major surprises or changes in messaging. The Fed decided to raise rates by 0.25% as expected and there were no revisions to the Statement of Economic Projections at this meeting. Fed Chair Powell’s tone at the press conference as the most notable departure from the prior meeting. While he has in the past scolded the markets for rallying on more dovish forecasts than the Fed’s own, this time he agreed to disagree with the market. The S&P spiked up about 4% following the meeting on these dovish “vibes” and did not return to its pre-meeting level until more than 2 weeks later.

The substance of Powell’s comments hadn’t changed much from the last meeting. The Fed’s message is simple: there is some disinflation in goods (which may be transitory, especially if energy costs rise), expected but not yet materialized future disinflation in housing, and significant inflation in services with no signs of slowing. Services inflation is more likely to become entrenched than goods inflation and is more closely related to the labor market, which remains exceptionally strong. Powell ruled out the possibility of raising the Fed’s inflation target above 2% and recommitted to tightening policy until that goal is achieved.

Data released since the meeting has supported the idea that the inflation fight is far from over. January Non-Farm Payrolls, released a couple of days after the FOMC meeting, showed blowout job growth of 517,000 compared to just 189,000 expected. Initial jobless claims have been below 200,000 for four consecutive weeks and, despite major layoff announcements from the tech sector, the December JOLTS survey showed layoffs and firings remained about 25% below the pre-pandemic trend. Inflation data has mostly surprised to the upside. January CPI rose 6.4% year-over-year compared to the market’s 6.2% expectation and PPI rose 6.0% year-over-year, well above the market’s 5.4% forecast.[1]

Markets are forward looking and, until recently, they looked right past the blip of higher rates to the second half of the year when the Fed would be slashing rates against the backdrop of a soft landing. Data released in the last three weeks have shifted this forecast a little, but not enough. September rate cuts are still priced into the Fed Funds futures curve. The yield curve has moved higher, putting the 2-year Treasury at its highest level since 2007. It could rise further if the market prices in a Fed Funds rate above 5% for most or all of 2023.  Conversely, the S&P 500 is still up over 4% year-to-date,[2] not reflecting the margin pressure companies would experience as higher wage and interest expenses run into the limits of their ability to raise prices.

Such a rapid monetary tightening following over a decade of near-zero rates and endless QE isn’t without risk.  Our thesis since last year has been that the Fed will raise rates and keep them elevated until either inflation is under control or “something breaks”. We’re seeing signs of weakness in commercial real estate, particularly offices, as the realities of remote work and higher rates collide with an oversaturated and leveraged market. Credit Suisse, a global systemically important bank, has seen its share price plunge to record lows amidst client outflows. Geopolitical tensions, particularly with Russia and China, have only escalated in 2023. Any of the above (or something else entirely) breaking could be the catalyst for future Fed rate cuts and would also put downward pressure on the risky assets that have rallied on hopes of looser policy. The math just doesn’t add up for us.

Sustainable Investing in the Time of Surging Energy Prices

If you are an ESG-centric financial advisor or investor investing in public equities over the past couple of years, you’ve probably noticed that you’ve been fighting an uphill battle. ESG large-cap funds tend to be underweight traditional energy, value stocks, financials, and commodity businesses. There are many different reasons any individual ESG fund might have these underweights. A manager may have decided to divest from extractive industries or companies that make their revenue selling or procuring hydrocarbons. Managers might limit their investable universe to stocks with specific minimum ESG scores or outcomes or decide to take a more thematic approach by investing businesses exposed to renewable energy and solutions that help consumers adapt to a changing climate.

These sustainable investment approaches have different motivations but no one method is necessarily better than another. Still, they can create unintended macroeconomic risks when put together in a portfolio. For example, when energy and commodity prices rose in 2022 in the wake of the Ukraine War, Morningstar reported that “only 35% of sustainable funds outperformed the Russell 1000 index during the year, while nearly 60% of their peers did so.”[3] In our opinion, the energy and commodities underweight was the cause of the short-term underperformance.

Despite a difficult 2022, this short-term volatility did not do much to change the long-term performance record of ESG funds against traditional funds. Morningstar also reports that “over the trailing three- or five-year period, an investor seeking long-term returns would have been better off in a sustainable fund than in one of its conventional peers. Of the 451 U.S. large blend funds an investor could have chosen in January 2018, 169 survived and beat the Russell 1000 Index, while 282 either closed or underperformed. Nearly 60% of the sustainable options succeeded, while only 35% of their conventional peers did.”[3] It seems that the most important decision investors could have made over the past couple of years was not the choice of ESG managers vs. traditional managers, but to understand how each manager’s ESG approach integrated with the rest of their portfolio.

For example, if you had an ESG large-cap manager structurally underweight value stocks and energy stocks, it would have been a great investment decision to pair that manager with a fund that thematically invests in water and sustainable infrastructure. The companies those funds would invest in would balance out the macroeconomic biases of the first manager by loading up on utilities, grid operators, and diversified energy businesses. Understanding how one ESG integration method offsets or enhances another while also tracking toward overall portfolio sustainability goals is what we believe is the best way to invest sustainably in the current market environment.


[1] Payroll, jobless claims, JOLTS, CPI and PPI data source: Bureau of Labor Statistics, Bloomberg

[2] Yield and performance data sourced from Bloomberg



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