Jeffrey Schulze, director and head of economic and market strategy at ClearBridge Investments, said that the year’s midpoint is a good time to reflect on the unfolding of recent events in relation to economic forecasts.
While the firm is currently tipped towards a recession being the most likely outcome by the end of 2023, Mr Schulze noted the unexpected robust rally for US equities against comparatively muted gains across most other economically sensitive financial markets including oil, copper and high yield bonds.
“Six months ago, 2023 was expected to witness the most anticipated recession ever, a view strengthened three months ago by three of the four largest bank failures in history. Equity markets have been unfazed by the regional banking crisis, rallying 15 per cent since Silicon Valley Bank’s collapse and seizure in mid-march,” Mr Schulze said in a recent market commentary.
“In fact, the S&P 500 Index is nine per cent above the average strategist forecast coming into the year and just a stone's throw away from reclaiming all-time highs.”
Meanwhile, the case for a soft landing has been bolstered by recent strength from the US housing sector, with the national home price index having bounced in its last two readings.
Mr Schulze said this supports the idea that the economy could experience a series of rolling recessions in specific sectors, while the overall economy might never enter a recession as pockets of strength in one sector offset weakness in another.
The key question for the second half of the year, he countered, is whether these factors indicate the early days of a new, durable bull market, or if the market is, instead, in the midst of a historically large and long bear market rally.
“The answer is muddied given strongly divergent outcomes implied by consensus estimates for the market and the economy,” Mr Schulze conceded.
Namely, bottom-up consensus showed that US equities are expected to return to positive EPS growth in the second quarter, with sharp acceleration later in the year.
By contrast, economists’ forecasts suggest GDP growth will continue to slow in coming quarters. While nominal GDP growth is expected to remain positive, Mr Schulze said this is largely a function of inflation, which is expected to cool further but remain well above the Federal Reserve’s 2 per cent target through 2024.
“This conflicting view presents a dilemma for investors on which camp has a more accurate read on how the next six months will unfold.”
Nonetheless, he clarified that ClearBridge’s forecast remains tipped towards a recession later this year, as per the continued “deep red” reading of the ClearBridge Recession Risk Dashboard, which experienced no signal change this month.
“As we reflect on the past six months, we find our broader views little changed despite all that has happened. We certainly did not expect such strength in US equities, and through earnings expectations would have slipped more by now, as has happened with economic forecasts,” Mr Schulze said
“We will not know for some time if a soft landing or a recession will emerge to determine who is right: optimistic stock market investors or more cautious economists.”