Muhlenkamp & Company Quarterly Letter – October 2023

Fellow Investors,

Let’s start, as we usually do, with a review of the most relevant developments that impact the investing environment. We’ll begin with inflation. The August reported CPI inflation was 3.7%, up from the June low of 3%. Since both 3% inflation and 3.7% inflation are above the Federal Reserve’s target of 2%, the Federal Reserve raised the Federal Funds Rate by .25% to a range of 5.25 – 5.5% at their July meeting. Longer-term treasury rates, though not directly controlled by the Federal Reserve, have also been rising with interest rates on 10-year Treasury Bonds moving from 3.8% on June 30th, 2023, to 4.5% on September 25th, 2023. This is likely partly due to the high deficits the federal government is running. The federal deficit in July was 7.6% of GDP (Gross Domestic Product), up from a pre-COVID range of 2.5% - 5% of GDP and not too far from the 10% of GDP deficit we ran during the ’08 – ’09 recession. Rising Treasury rates have caused other interest rates to rise as well. Worth highlighting is the 30-year mortgage rate which began the year at 6.6% and rose to 7.6% by September 22nd, 2023. Adding insult to injury, the average gas price in the U.S. increased by about 10% in late July and is now roughly $4.30/gallon.

So far, the economy is holding up reasonably well. Inflation-adjusted GDP grew at a 2.1% annual rate in the second quarter according to the Bureau of Economic Analysis. Unemployment, although well known to be a lagging indicator, continues to look pretty good with the August unemployment rate coming in at 3.8%, up a bit from the January low of 3.4%.

We said a year and a half ago when the Fed started raising rates that they would continue until something broke. In the second half of ’22 they “broke” the housing market as buyers balked at higher mortgage rates. Somewhat surprisingly new homes sales have recovered nicely in ’23, though sales of existing homes are dismal. It turns out higher mortgage rates have kept existing homes off the market as those homeowners are reluctant to exchange the low-rate mortgage on their old home for a higher rate on a new purchase, so most of the homes available for purchase are new construction. In March a couple of regional banks “broke” as their depositors fled. Some quick, generous lending by the Fed kept that problem from spreading, at least so far. We continue to keep an eye on the banks as higher rates and changing work patterns have combined to hit commercial real estate values pretty hard, and some banks are deeply involved in that industry.