Jeffrey Schulze
With clarity on tariffs coming into focus, one of the major sources of uncertainty that has weighed on businesses, consumers and financial markets is finally waning.
“Combined with tax incentives and a fiscal boost from the One Big Beautiful Bill Act (OBBBA), corporate animal spirits are poised to pick up this fall as business leaders can now execute hiring and capex decisions that had been put on hold for lack of visibility. In fact, several M&A transactions have been announced in just the past two weeks, including a merger between railroads Union Pacific and Norfolk Southern and a tie-up between regional banks Synovus Financial and Pinnacle Financial,” notes Jeff Schulze, head of economic and market strategy at ClearBridge Investments, a global investment manager.
The two biggest risks that lie ahead are a further slowdown in the labour market and elevated equity valuations. Last Friday’s +73,000 jobs report caught many (including us) by surprise. “Although we had previously stated that job creation below 100,000 per month could be the “new normal” given DOGE-related layoffs, an aging population and reduced immigration flow, we did not expect the labour market to slow to this degree so soon,” adds Schulze.
Even more strikingly, the -258,000 revisions to May and June bring the three-month average to a paltry +35,000 trend pace, meaning there is little buffer for future disappointments. With job creation at stall speed and tariff headwinds ahead, a negative payroll print in the coming months is a strong possibility, which may conjure up recession fears.
While this may be cause for near-term volatility, the July jobs report wasn’t all doom and gloom. The release showed steady wage gains and a pickup in average weekly hours, both of which should help support spending. Aggregate weekly payrolls, a good proxy for aggregate labour income, rose by 5.3% year over year, tying the best reading since March 2024.
“Put differently, a slowing labour market is a normal late-cycle dynamic, but it doesn’t look recessionary at this juncture,” he says.
The other primary risk comes from elevated equity valuations, with the S&P 500 Index trading at 22.1x expected next-12-month (NTM) earnings. Valuation is a famously poor timing tool, however, and there are several structural reasons why current valuations look historically expensive, including the composition of the market itself. Higher-P/E sectors such as information technology make up a larger share of the benchmark today, while groups that typically trade at lower multiples such as energy are a smaller weight; this pushes the overall market multiple higher.
Another key driver of higher multiples is superior fundamentals today compared to the past, with the index sporting higher operating margins, better revenue growth, stronger free cash flow generation and lower leverage.
Schulze adds,” While these shifts cannot fully explain higher valuations, it’s rare to see multiple contraction in an environment of elevated earnings growth and recent rate cuts, as is the case today. Although valuations are “stretched” compared to history, there are many reasons to believe equities can remain expensive in the years to come.
“That said, the resurgence of “meme stocks” over the past few weeks and concerns on the labour front suggest that the risk-reward may be skewed unfavourably in the near term. Should a pullback emerge, we believe long-term investors would be rewarded by deploying dry powder into weakness given our expectation that the economy (and by extension corporate profits) are likely to accelerate over the next 12 months.”
