Video Update: The Most Important Thing to Watch in 2023 (It’s Not the Fed)

Being a long-term investor means having a portfolio that can weather all kinds of markets.

That’s why it’s crucial to be aware of what’s happening in the broad markets and economy.

In today’s video, Chief Analyst Adam Galas breaks down last week’s economic reports and shares what the most important results were.

He’ll parse through all the data – like the likelihood and timeline of a recession in 2023 – so you don’t have to. And share how we structure our Fortress Portfolio to remain resilient.

Having this knowledge at hand can help you prepare for this upcoming year and beyond.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Intelligent Income Investor

Welcome, Fortress Portfolio members, to another weekly video update.

As promised last week, today we're talking about the Fed (Federal Reserve).

But more importantly, we're talking about jobs market, the most important thing to watch in 2023.

Now you might have thought it was the Fed, but not quite. I’ll explain why shortly.

In recent weeks, we've talked about how the worst-case scenario for the stock market is actually a potential 30% decline if we get a severe recession.

Well, there's pretty much only one way that we can get a severe recession, and that's due to the Federal Reserve.

Of the last nine times the Fed has started hiking rates, eight times it’s caused a recession, or at least was partially responsible for the recession.

Last week not surprisingly, the Fed hiked rates by 0.25%.

After the conference call, stocks shot up by 2.5% in a matter of minutes.

The reason for this was largely because of what Jerome Powell said about disinflation, something he mentioned 11 times in that speech.

Now what disinflation simply means is that inflation is coming down. So the Fed admits, it looks like we've hit peak inflation and it's coming down at a steady clip.

The next day, we had the blowout jobs report.

It shocked economists who were expecting 185,000 jobs.

The jobs report listed almost three times that much, 517,000.

Now granted, about 200,000 of these are likely to be seasonally adjusted and will decrease in the coming months, so it's probably closer to 300,000.

But that still means that we're creating around 300,000 jobs per month, or a rate of 3.6 million per year, at least in start of the year.

Last year, we had 4.6 million. A fantastic year for workers. For context, Bloomberg estimates that unemployment -- to stay stable – would need to be at 30,000 per month.

So we’re generating 10 times more jobs than we need to keep unemployment stable, and unemployment is 3.4%.

That’s lower than pre-pandemic levels. In fact, that’s the lowest it’s been in 54 years.

You have to go back all the way to May 1969 to see unemployment that low.

Now we also had something called the household survey.

The jobs report is technically two reports, the establishment survey and the household survey.

The household survey estimated that 900,000 jobs were created.

Now obviously, that's probably too high. But it does mean there's a chance that the revisions in the next few months could actually go up, rather than down.

What does this all mean? Well, it means that the job market is absolutely red hot right now.

And for confirmation of this, we can look at the weekly new unemployment claims, which are coming in at 183,000 per week.

For context, Moody's estimates 250,000 is consistent with a strong economy and 300,000 would be needed for a mild recession.

We're at 183,000, which adjusted for population, is the lowest ever recorded in the United States.

So, why is this a bad thing, and why is the job market the number one thing that we need to watch in 2023?

Well, because there's basically three things that could continue to cause inflation.

And remember, that's the thing that the Fed is focused on like a laser: slaying that inflation dragon.

There are three components to inflation.

There's goods to inflation, commodity inflation, and service inflation, which includes things like rent.

Now, rent and housing prices are finally starting to come down, as expected.

Commodity prices have collapsed. Goods prices have fallen.

Something like 20% decline in used cars, for example.

Wage inflation, on the other hand, is critical to services, which is 70% of the US economy.

In other words, while the Fed is saying, yes, inflation has come down by about 3% off its highs, they're worried that it could get stuck at 4 to 5%.

What could cause that?

Wage growth staying strong, above 4%, and productivity remaining weak.

Now the good news is, productivity came in at 3% last quarter.

Why does the productivity matter? Because long-term inflation is basically equal to wages minus productivity.

So that's the good news. 4.3% wages, 3% productivity. That's consistent with 1.3% inflation, which the Fed would love to see. So would the market because it means the Fed could cut to around 2%.

But the Fed is worried that if unemployment keeps dropping, wages could actually start to rise. That could cause inflation to get stuck at 4 to 5%.

And as we've discussed in recent weeks, that could cause a major problem for the bond market and the stock market.

That's because before the jobs report, the bond market was thinking the Fed was going to hike just one more time, 25 basis points in March, and then stop at 4.5%. And finally cut twice by the end of the year.

That's what the stock market was picking up on, and that's why we had the eighth best January in U.S. market history.

So if the job market stays red hot, then this could essentially force the Fed to keep hiking up to 5.5% by July, according to Toronto-Dominion Bank (TD), or possibly even higher.

In fact, we've now seen the first estimates from the likes of Apollo Management (APO) saying that their base case is not a soft landing or a hard landing, but what they'd call the “no landing scenario” in which the economy doesn't even slow down, it just keeps chugging along at 2 to 3%.

The problem, of course, is that the Federal Reserve would then have to keep hiking because they're terrified of recreating the errors of the 1970s when they cut, raised, cut, raised again, cut again. Then finally inflation just got so out of control that Paul Volcker had to come in, nuke the economy with 20% interest rates, and cause two severe recessions.

So this is why the job market is important.

Now you might think, well, if the Fed slows the economy with its hikes and that would slow job creation, what's the problem?

Well, the problem is, generally it takes 12 to 18 months for a rate hike to fully make its way through the economy.

And when did the Fed start hiking rates? March of 2022.

It's February of 2023, meaning that other than things like the housing market and the most interest rate sensitive parts of the economy, we haven't even seen the effects of these rate hikes yet.

So the problem is, the Fed doesn't feel that it can take a pause of 12 to 18 months to see what's going on.

So if the job market stays too hot, the Fed basically has to keep hiking, possibly to 6% or even higher according to some economists.

And that, combined with quantitative tightening – which is reverse money printing – actually means we would get up to an effective interest rate of about 8%.

Right now, according to the San Francisco Fed, it's around 6.5% effective rates. Before the Great Recession – before the Fed's balance sheet was so big – it was the equivalent of having rates at 6.5%. Meaning the Fed has to go to 6%, effectively 8%.

Well, that would pretty much guarantee a severe recession. Which currently, according to an Ernst & Young survey from January, many CEOs actually expect.

In fact, 41% expect a short but severe recession, while 98% expect an overall recession of any kind in 2023.

Now the good news is, the economic data is starting to show consistency with a mild recession.

In fact, so mild it could be the mildest in history.

Bloomberg’s consensus is that the recession starts next quarter, lasts six months, and for the full year we get 0% growth.

The FactSet consensus is that the recession has begun, will last six months, and we will get plus 0.1% growth in 2023.

How good is that? Well in 2001, that was the mildest recession in U.S. history with the economy contracting 0.4%.

In other words, thanks to all that stimulus spending in the pandemic, corporations with $7 trillion in cash on their balance sheet, consumers still with $1 trillion in excess savings, and a job market that just won't quit… Consumers will be able to keep spending and any economic recession is likely to be mild.

Which, of course, is good news for corporate earnings.

In terms of the overall stock market, though, that could be a problem.

Because remember, the reason stocks went roaring higher in January was the believed idea that the Fed was going to stop soon and cut by the end of the year.

Well, if the job market stays too hot, that's not going to happen. But main street will be just fine.

Corporate earnings could become flat or down slightly, which will not threaten the dividends of your Fortress Portfolio.

Because remember, these are some of the strongest companies on Earth. Strong balance sheets, talented and adaptable management teams, excellent long-term risk management, and very solid and dividend-friendly corporate cultures.

So now, let's move on to some subscriber questions.

Since I've recommended so many dividend stocks, Adam R. would like to know:

How do they actually pay us? Do they send checks? Is it via brokers? When do you get paid?

Well almost every time, these days, the dividends get deposited directly to your account… Pretty much on the payment date, which you'll see in each issue of the newsletter.

We have a table showing the next month's dividend payment dates and what the day is that you have to buy the stock in order to get the next dividend.

This is why it's so important to have a safety and quality model that you trust.

Ours is a thousand-point safety and quality model that looks at the most time tested and important and validated metrics.

Things like payout ratios, dividend growth streaks… How long has a company not cut its dividend? Credit ratings, long-term risk management ratings, short and long term growth outlooks, and many other factors.

But all these are actually based on dividend safety.

So one final note about Dividend Kings and Dividend Aristocrats, companies with 50-plus year dividend growth streaks and 25-plus year dividend growth streaks.

This is an important sign of quality and income dependability. Of course, it is no guarantee that dividends can't come under pressure.

General Electric, for example, is the most famous former Dividend Aristocrat that ended up cutting its dividend no less than five times on an annual basis.

But the thing about Dividend Aristocrats to remember is this. It's all about probabilities. In the Great Recession, the probability of a Dividend Aristocrat cutting its dividend was 50% less than the S&P 500.

And in the pandemic, it was 80% less, five times less likely.

So we do carefully monitor the fundamentals and the safety. We look at things like cash flows, expected future cash flows, the balance sheet, credit ratings, risk management ratings.

We even look at something called credit default swaps, which is the bond market's real-time fundamental risk assessment.

We do this so that you can have confidence that your dividends are safe, will keep growing, and will help you achieve your financial goals.

Thank you for joining us for another video update for the Fortress Portfolio, and I'd like to remind you to please send in your questions.

Just keep in mind, legally we're not allowed to give personalized investment advice.

I look forward to answering more of your questions in future videos, as well as in future issues of the Fortress Portfolio.

This is Adam Galas wishing you safe investing and a happy and healthy week.