Second Quarter 2023 Podcast

[Carolyn Goldhaber] Welcome back to this quarter’s Thoughts on the Current Environment podcast. I’m Carolyn Goldhaber, President of Segall Bryant & Hamill. And today I’m joined by Ralph Segall, our CIO, to discuss the key highlights from our second quarter 2023 newsletter. Hi Ralph, thanks for joining me today.

[Ralph Segall] Good to see you, Carolyn.

[Goldhaber] In today’s episode, we will explore how regime change continues to unfold and the role that inflation has played within the change. Ralph, over the past year, you’ve talked about regime change, which describes the end of an era of free money into a rising interest rate environment. Just in the first three months of 2023, we have seen an additional two quarter percent in interest rate increases which brings the total number of increases to nine within the span of one year. Do you think we’ll continue to see rates rise throughout 2023, continuing fears of a recession?

[Segall] Thanks, Carolyn. Regime change, which is the idea that we developed over the last couple of years that administered interest rates, the central banks of the world keeping interest rates pinned at zero, were going to cause troubles for both the financial markets and the real economy once they were finally forced to end, seemed to be playing out in the last year or so. Recall that Jay Powell, the chairman of the Federal Reserve, announced the end of quantitative easing in December of 2021 and he said that interest rates would start to rise in the first quarter of 2022. And lo and behold, that’s what happened. As you pointed out, interest rates have continued to rise straight through the first quarter. The first domino that fell when regime change began to play out was the behavior of the financial markets. The stock and the bond market in 2022 each had a pretty bad experience.

I think the stock market experienced its sixth worst year in the last 95 years. And the bond market, depending on whether you’re looking at corporates or just Treasuries, had either its first or second worst period. It started to spill over in the first quarter with two bank failures. Two banks out in…well Signature Bank and Silicon Valley Bank were both taken over by the FDIC because they ran into problems primarily with interest rate mismatches and that led to a run on banks in general for a few day period until some calm came back. One of the issues that something like regime change will produce is you can’t really anticipate or expect where the consequences are going to play out. They’re going to happen. You don’t know where. Are we finished with them? Probably not.

In an economy as complex as ours, something as massive a change as we’ve seen in interest rates is going to, still has to play out. Whether that means there will be more interest rate increases or not, we don’t predict, it’s not our style to try to time the bond market or fixed income market like that. So yes, there could be another increase coming in here, but more likely than not, because rate increases operate with a lag, the die is cast, and it’s going to happen. Does that mean inflation’s going to slow? Probably. It could happen, goodness knows, but I can’t foresee inflation accelerating from here. I don’t think the strength of the economy would allow for that. Our biggest concern is going to be what we see playing out in terms of corporate profits, and that has to do with the fact that if inflation does slow, companies aren’t going to be able to pass through price increases as easily.

My company’s price increase is the inflation you experienced, and if I can’t raise prices, my margins are going to suffer. I’m facing higher labor costs, I’m facing higher interest rate charges if I do have any borrowed money that I have to pay interest on. And if the economy is slowing, my operating rates are going to be lower, which means that I’m going to be less efficient. Wall Street right now is still expecting higher profits for companies in general for 2023. We’re very apprehensive of that.

[Goldhaber] Okay, that makes sense. So can you translate how these dynamics might change the composition of clients’ portfolios going forward?

[Segall] Well, one thing I can tell you that won’t change is the way that all strategy teams approach their jobs. We are a firm that’s built on fundamental, bottom-up research that gives a lot of credence to risk in our selection process. It’s the process that we followed for the last almost 30 years. We know that it’s tried and true, our clients appreciate that, so that won’t change. But my guess is, that the kinds of companies that we wind up finding attractive could very well be in for a shift. For example, or just as an illustration: one of the things, trends that we know is going on is the decarbonization of the economy. Electrification, if you will. There are going to be a lot of companies in industries that we might not have found quite as interesting in the past that suddenly will be beneficiaries of the Inflation Reduction Act from last year. That’ll be part of the entire process of taking carbon out and replacing it with sources of electricity. We could discover some companies that will make more sense, have better earnings visibility, and where we can make a judgment that valuations might shift. What we are doing won’t change, but where we’re looking, we think will probably be… We’re going to find opportunities out of a different opportunity set than we’ve experienced in the last 15 years.

[Goldhaber] Thank you, Ralph, for sharing your perspectives today and I’m looking forward to continuing our conversation next quarter. And thanks everyone for listening.