Jeffrey Schulze

As investors digest implications of a higher US consumer price index reading and a historic summit between US President Donald Trump and Chinese President Xi Jinping, ClearBridge Investments says investors needn’t shy away from new highs, particularly when earnings expectations are holding up.

“We are staying disciplined, using volatility as an opportunity to deploy capital, while modestly favouring the stronger earnings revisions and more reasonable valuations available in non-U.S. equities,” Jeff Schulze, head of economic and market strategy at ClearBridge Investments, says.

“The rebound in US equities from late-March lows has been swift and broad-based, with equities rising 13.6 per cent since their trough. April alone accounted for 10.4 per cent of the gain, making it the best monthly performance since 2020 and the 12th best monthly return in more than 75 years.

“A key reason we continue to believe US markets can climb higher is the green overall signal emanating from the ClearBridge US Recession Dashboard,” Schulze says.

The dashboard, which tracks a range of economic indicators, has now returned a fully green reading after Housing Permits, previously delayed by government shutdown data disruptions, stabilised and flipped from yellow to green.

The bullish signal comes against a complex macro backdrop. Wednesday’s CPI print showed US inflation running at 3.2 per cent annually, above consensus forecasts, reinforcing expectations that the Federal Reserve will keep rates on hold through mid-year. Separately, the first face-to-face meeting between President Trump and President Xi since 2023 has raised hopes of a de-escalation in trade tensions, though markets remain cautious.

Schulze says, “The US labor market has alternated between positive and negative prints for the past 11 months, with net job creation modestly positive on balance. More broadly, the labor market has cooled over the past few years primarily due to drags from changes in immigration policy and the aging population demographics. It still does not appear that artificial intelligence (AI) is driving widespread layoffs, although there are pockets of softer hiring.

“We are encouraged by initial jobless claims – our economic canary in the coalmine – notching its lowest total since 1969 last week alongside other recent signs of labor market stabilization. Looking ahead, we remain on watch for AI-driven job losses, but we are also eyeing AI job creation as previously unimaginable jobs emerge on the back of this technological advancement.”

The geopolitical risk has not disappeared.

“The equity rally does appear to be vulnerable to a re-escalation of the conflict in the Middle East, particularly if disruption to trade in the Strait of Hormuz lasts longer than is currently expected (reopening around mid-year). Given that the bulk of the April rally occurred in conjunction with the de-escalation of tensions in the Middle East, we believe the risk of a prolonged supply bottleneck is real.

“We continue to believe that the economic impacts should remain manageable and not result in a meaningful economic slowdown: further pullbacks would likely represent buying opportunities, in our view. At the same time, we do not believe investors should be scared off by the markets being back at all-time highs.

“Our work (counterintuitively) shows that investing at new highs has historically outperformed deploying capital when the benchmark is below peak.

The S&P 500 is trading back above 20 times on a forward price-to-earnings basis, a level some investors treat as a ceiling.

“But the benchmark has traded above that multiple 63 per cent of the time since first crossing the threshold in April 2020, without acting as a headwind to returns. Over the past six years the index has risen 147.5 per cent, roughly double the long-run average, underpinned by cumulative next-12-month earnings growth of 137 per cent.”

“First-quarter results, now past the two-thirds mark by market capitalisation, have delivered strong upside surprises, with information technology, energy and materials sectors showing notable strength. Consensus expectations for mid-teens earnings growth have continued to rise rather than follow the typical seasonal pattern of downward revision.”

“We continue to believe non-U.S. equities present an attractive opportunity relative to domestic US stocks. Emerging markets (EM) look particularly compelling despite their recent strength, with robust revisions to earnings expectations powering their returns and supporting a continued constructive fundamental outlook.

“Valuations also remain less challenging than in the U.S., and although some EM economies are significant oil importers, the adage that the stock market is not the economy rings even more true in the case of many EM countries.

“Developed non-U.S. equities should also benefit from positive earnings revisions and attractive valuations, although to a lesser degree.”

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Jeffrey Schulze

Strong market entry points are rarely found during moments of comfort or clarity. Instead, the most attractive buying opportunities are typically associated with periods of market stress. From there, equities tend to climb a “wall of worry,” advancing in the face of issues such as recessions, inflation spikes, geopolitical tensions, policy errors and lofty valuations, according to ClearBridge Investments.

“This dynamic exists because what matters most for financial markets is if reality turns out better or worse than what has already been priced in. As a result, when expectations are low—as they are today—stocks can push higher if subsequent events turn out better than feared. From this perspective, scepticism is not a barrier to a bull market but rather part of its foundation. Doubts will eventually be assuaged and sentiment will improve, which should lead to hedges being unwound and cash moving off the sidelines,” says Jeff Schulze, head of market and economic strategy at ClearBridge Investments.

At present, the biggest “bricks” in the wall of worry include stagflation, private credit risks, job losses due to artificial intelligence (AI) and market concentration.

“The first is directly related to oil prices. How long these stay higher appears to be the most significant worry for investors at present. While current conditions invite comparisons to the 1970s, the US economy is structurally different today—with energy independence achieved and energy intensity lower—suggesting the transmission from higher oil prices into growth and inflation should be more muted than the past.”

The most recent oil shock in 2022, sparked by the Russian invasion of Ukraine, did not drive a US recession as the aforementioned structural changes were already in place.

“The second brick in the wall of worry has been private credit. The opaque nature of the asset class has led some to conclude that it is ripe to be the next shadow-banking accident. However, deeper analysis shows that while risks certainly exist, they are unlikely to generate substantial enough macroeconomic spillovers to cause a recession.”

At its core, private credit uses long-term funding that is gated, which limits the risk of a problematic “run on the bank” dynamic where investors all look to exit at once. Use of leverage in the asset class is moderate, with IMF research suggesting that aggregate bank exposure to the industry amounts to $300 billion, or less than 2% of overall loan books. Although private credit has witnessed an uptick in defaults recently, its overall size amounts to a fraction of what mortgage-backed securities (MBS) were heading into the Global Financial Crisis (GFC). Private credit today is equivalent to 6% of gross domestic product (GDP); MBS in 2007 was approximately 30%.

The third brick in the wall of worry has been fear of an AI-induced layoff cycle or “job apocalypse.”

“This fear is understandable. If AI displaces workers faster than it creates new jobs, overall household income would fall, demand would weaken and corporate profits would deteriorate. Although February’s soft jobs report supported this recessionary narrative, a closer examination of the data suggests that other factors are playing a larger role than AI in slowing the pace of US job creation. These include changes in immigration and trade policy, alongside the continued aging of the US population and DOGE-related efforts to shrink the federal workforce,” he notes.

“One overlooked component of the debate around an AI-induced layoff cycle, in our view, is the fact that throughout history, major technological advances have led to job creation alongside job destruction. This creative destruction process means that significant value and jobs are created by new businesses, offsetting some of the losses from the disruption of legacy firms,” he adds.

“Already, AI has created jobs building infrastructure (such as data centers), and we believe these opportunities will broaden in the years to come. The pace of job creation relative to destruction will be crucial in determining the path of the labor market and by extension the US economy, but history shows that the overall effect is usually a positive one. Only 40% of today’s jobs existed 85 years ago, suggesting investors and workers alike should embrace the opportunities presented by AI.

“Similar fears regarding a “job apocalypse” were present during the late 1990s internet revolution. However, the economy benefited as new occupations were created in areas that were previously unimaginable, such as e-commerce, video games and content creators—yes, “influencers.”

“History shows that when we look back on 2026 in a decade or two, the likelihood is high that a substantial number of jobs will exist in areas we can’t even dream of today, built on the back of advances made possible by AI. Put differently, creative destruction is a feature rather than a bug of technological change and a positive force for economic growth. In fact, this very idea was awarded the Nobel Prize in economics last year.”

The fourth and final brick is elevated US equity market concentration. The 10 largest companies in the S&P 500 currently account for 38% of the benchmark and trade at a 5.4x multiple-point premium based on expected next-12-month earnings. Given this backdrop, passive large cap benchmarking no longer offers a broadly diversified and balanced portfolio, but rather an increasingly concentrated exposure to the most richly valued part of the index.

Admittedly, it is hard to imagine a world where today’s largest companies are not dominant forces over the next decade. However, a myriad of factors may alter the earnings trajectory of the current leaders as AI matures and the competitive landscape changes. The aftermath of the tech bubble may serve as a good case study, particularly as it coincides with the last period of elevated S&P 500 concentration.

The prospects of the 10 largest S&P 500 constituents at the peak of the tech bubble (March 2000) have varied widely over the subsequent 26 years. Four have had negative price returns, and only three have outperformed the benchmark. Notably, none of the 10 have outpaced the equal-weight S&P 500. While the current environment is certainly different than the dot-com era, this case study is a helpful reminder of the dynamic that may play out in the coming years. Importantly, it also illustrates the opportunity for active managers that can accurately assess the changing competitive landscape and embedded valuations of today’s leaders.

“With multiple bricks making up the wall of worry today, investors can be tempted to treat each unsettling headline as the tipping point for the next crisis. Comparisons abound between higher oil and stagflation in the 1970s, and between current private credit risks and MBS ahead of the GFC, for example. However, many of these issues are more nuanced than is typically understood.

“We conclude that these worries are likely forming the foundation for a renewed rally as fears subside, a typical feature of bull markets. Given our constructive economic and market outlook, we believe the market will ultimately climb today’s wall of worry as investors’ leading fears are assuaged. As a result, we view the current pullback as an opportunity to deploy capital for long-term investors,” notes Schulze.

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Jeffrey Schulze

Escalating tensions in the Middle East have once again rattled global markets with oil markets at the centre of investor concern. The possibility that Iran could disrupt the Strait of Hormuz, a critical chokepoint through which roughly 20%–30% of global seaborne energy trade passe, has driven a sharp move in energy prices.

“While geopolitical shocks often create short-term turbulence, history suggests that investors should resist the urge to retreat. In fact, periods of geopolitical stress have frequently created buying opportunities,” Jeffery Schulze, Head of Economic and Market Strategy, ClearBridge Investments says.

“Looking at past geopolitical flare-ups, the S&P 500 Index has, on average, delivered positive returns over the one, three and six-month periods following such events.

“Even during larger conflicts that escalated into full-scale wars, the record is mixed rather than uniformly negative. In many cases, broader macroeconomic conditions ultimately proved more influential than geopolitical developments.

“Some of the weakest market outcomes following military escalations occurred during periods when the US economy was already entering recession — including 1973, 1979 and 1990. These episodes suggest that economic cycles, rather than geopolitical events themselves, tend to be the primary drivers of sustained market weakness.”

He adds “But for financial markets today, the most important transmission mechanism from the Middle East conflict to the global economy is oil. Higher oil prices historically acted as a significant drag on US growth. However, the structure of the US economy has changed considerably in recent decades.”

The United States is now a net producer of energy rather than a net consumer. As a result, rising oil prices create a more balanced economic effect. “While higher fuel costs can dampen consumer spending, increased energy production can also support employment, investment and corporate profits within the domestic energy sector,” says Schulze.

“Another structural shift further reduces the economic impact of rising energy prices: American households now spend a much smaller share of their budgets on energy than they did historically.

“Today, direct spending on energy goods and services accounts for less than 4% of US consumption. That is well below the nearly 5% share seen in early 2022 when Russia invaded Ukraine, and even further below the levels recorded ahead of the Gulf War in 1990 and the Iraq War in 2003.”

This decline reflects decades of efficiency improvements, including higher fuel economy standards, as well as rising overall household income. As a result, increases in energy prices tend to exert less pressure on consumer finances than in previous geopolitical crises.

While rising energy prices could temporarily lift headline inflation, the Federal Reserve is unlikely to react aggressively.

Oil price spikes are generally viewed as supply shocks, something monetary policy is less effective at addressing. During previous energy-driven inflation episodes, including those following pandemic supply disruptions, the Fed has tended to focus more heavily on underlying inflation trends.

In particular, policymakers closely monitor “core” inflation measures such as core Personal Consumption Expenditures (PCE), which exclude volatile commodity prices like oil. These measures are likely to show a much smaller impact from energy price movements.

“Given this dynamic, we continue to expect the Federal Reserve to begin cutting interest rates in the second half of the year.

“Despite recent volatility, the broader economic outlook remains constructive. While the events in the Middle East have introduced some uncertainty, they have only modestly altered our economic expectations heading into 2026.

“History suggests that geopolitical shocks rarely derail markets for long. More often, they create temporary dislocations that long-term investors can use to their advantage. For investors willing to look beyond short-term headlines, the evidence remains clear: buying geopolitical dips has historically been a rewarding strategy,” he notes.

 By Jeff Schulze, Head of Economic and Market Strategy

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Jeffrey Schulze

The U.S. federal government shutdown has halted most economic data releases over the past month. While the timing is suboptimal given the cooling U.S. labor market, this does not mean that investors are “flying blind,” as many alternative private sector data sources are available, according to ClearBridge Investments.

“Although these datasets often have narrower scope or less depth, we monitor them even when the federal government is open for business to help supplement our understanding of the U.S. economy. At present, we are heavily focused on these alternative data sources, given the disruption to the flow of government data,” notes Jeff Schulze, Head of Economic and Market Strategy ClearBridge Investments.

Fortunately, seven of the 12 indicators on the ClearBridge Recession Risk Dashboard come from sources not impacted by the shutdown and that continue to be updated. None of these seven indicators experienced a signal change in October.

For the other five, many alternative private sector data sources enable us to monitor current conditions.

“We are evaluating alternative sources for the five ClearBridge Recession Risk Dashboard indicators impacted by the shutdown: Housing Permits, Jobless Claims, Retail Sales, Wage Growth and Profit Margins. Our analysis suggests a continuation of recent trends for each and a continued overall green signal for the dashboard.

“With profits and margins continuing to expand, we believe the probability of a pickup in layoffs tipping the economy into a recession remains low. Instead, we remain confident that economic growth will continue to moderate but stay on a healthy trajectory,” says Schulze.

The ClearBridge Recession Risk Dashboard was created in January 2016. References to the signals it would have sent in the years prior to January 2016 are based on how the underlying data was reflected in the component indicators at the time.

Four of the five indicators impacted by the government shutdown focus on the U.S. consumer, which is unfortunate given the outsize role consumption plays in the U.S. economy.

“However, the silver lining is that, given this importance, an abundance of additional data sources can be utilised to gauge the health of the consumer.

“To monitor future housing activity, we evaluate publicly available datasets such as the Dodge Construction Network’s residential building starts, which rose by 3.6% in the latest release. While the dashboard focuses on permits as opposed to starts, the two concepts are closely related.

“We complement this data with survey data from the National Association of Home Builders (NAHB) as measured by the NAHB/Wells Fargo Housing Market Index, which saw an uptick in sentiment, suggesting construction activity could pick up into 2026. The positive tone from these two datasets is tempered by weekly purchase applications from the Mortgage Bankers Association, which fell in October.”

Combined, the near-term picture for housing is mixed, consistent with the latest available yellow signal for Housing Permits.

The second dashboard indicator on hold has a more direct substitute. Jobless Claims are normally reported by individual states and then aggregated and adjusted by the U.S. Department of Labor. Because the states themselves are not impacted by the federal government shutdown, the underlying jobless claims data still exists — it just needs to be compiled.

Several Wall Street banks, research boutiques and economic think tanks have been doing this during the shutdown, and their work clearly shows that the trend in jobless claims has remained steady over the past month. This means the indicator likely remains green.

“We take comfort from the fact that Fed Chairman Jerome Powell expressed a similar view that “available evidence suggests that both layoffs and hiring remain low” during last week’s Federal Reserve Open Market Committee (FOMC) press conference.”

Retail Sales also has a straightforward proxy: the Chicago Fed Advance Retail Trade Summary (CARTS). CARTS is a nowcasting tool similar to the Atlanta Fed’s GDPNow tracker, but for retail sales.

The CARTS estimate for the latest data is that retail sales ex-autos advanced by +0.3% sequentially and +0.2% when adjusted for inflation. These readings would be consistent with a continued green signal for Retail Sales, as well as other alternative data sources focused on consumer spending, including Johnson Redbook’s same-store sales and credit card spending data, both of which suggest consumer spending continues to grow.

Wage Growth is the final consumer indicator impacted by the shutdown.

Data from ADP and Indeed.com both point toward wage gains continuing at their recent pace in the latest available data. Further, steady wage trends are consistent with Powell’s comments during the FOMC press conference that U.S. labor market trends have not meaningfully shifted since the shutdown began.

The fifth and final dashboard indicator impacted by the shutdown is Profit Margins, which comes from the National Income and Product Accounts data, a subcomponent of the quarterly GDP release.

As a proxy, we evaluate a narrower slice of corporate profits by aggregating earnings releases from public companies. Public companies that have reported so far continued to see margin expansion during the most recent quarter and sell-side analyst expectations are that on balance this will be the case overall (including unreported companies).

In all, combining the seven indicators that can be updated with the best available proxies for the other five, we believe the overall dashboard remains firmly in green territory. With profits and margins continuing to expand, we believe the probability of a pickup in layoffs tipping the economy into a recession remains low. State-level initial jobless claims data further suggests that this dynamic is not playing out at present.

“Combining this with other key economic trends remaining intact — even in the absence of official data — bolsters our confidence that economic growth continues to moderate but remains on a healthy trajectory,” adds Schulze.

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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.”

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Jeffrey Schulze

In the recent ‘Anatomy of a recession’ analysis Jeff Schulze, Director and Head of Economic and Market Strategy at ClearBridge Investments, noted that the probability of US consumer strength overpowering trade-related headwinds appears lower in 2025.

While the labour market remains healthy with monthly job creation averaging 144k so far in 2025, this pales in comparison to the red-hot labour market of 2022 when monthly job creation averaged 380k (and 603k in 2021).

“Further cooling in the labour market could prove problematic for the US economy given the fact that labour income represents the majority of spending power for most Americans. Importantly, consumers appear to have already begun to retrench in the face of elevated uncertainty.

“We continue to believe that Initial Jobless Claims are the single most important economic indicator to watch – our canary in the coalmine – in determining the path of the economy. So far, claims have held up extremely well in the weeks following ‘Liberation Day’, and we believe the late-April jump is a seasonal adjustment issue related to the timing of spring break in New York that has cropped up over the past few years but will likely reverse in early May,” added Schulze.

However, slipping profit margins means there is less of a buffer should the labour market weaken or demand slow in the coming months. “This leads us to believe that the risk-reward trade off facing both the economy and financial markets skews to the downside at present,” he said.

A positive change in trade policy or a renewed focus from the Trump administration on its supply-side agenda (deregulation, tax cuts/fiscal support) could shift the skew to be more favourable. However, prompt action is likely needed in order to counteract the negative (and building) effects of elevated uncertainty and margin pressure.

“As a result, we believe that a focus on higher-quality companies with proven track records managing through periods of turmoil such as dividend growers should continue to benefit investors.

“Notably, companies that have been able to consistently raise their dividends recently closed one of the largest 12-month performance gaps witnessed in the last 30 years relative to the S&P 500. Following similar periods of underperformance in the late 1990s and early 2020s, dividend growers then went on to outperform the S&P 500 in subsequent years.”

By Jeff Schulze, Director and Head of Economic and Market Strategy 

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Andrew Canobi

Andrew Canobi, director of Australia Fixed Income for Franklin Templeton Fixed Income says “A look at the instrument panel in the US reveals little showing up in the gauges that says landing imminent.  Employment firm and now core CPI ex-housing motoring along – 3 month annualising well north of 7%!

“The data is simply not providing cover for the Fed to cut in June or July as yet.  It may start to do so but core inflation has accelerated since Q4 2024, so things need to reverse course pretty quickly for this to be a chance.  Take out a June or July cut and cuts become difficult for the Fed this side of the Presidential election.”

Jeff Schulze, Director and Head of Economic and Market Strategy at ClearBridge Investments, a global investment manager notes “The March CPI release came in hotter than anticipated with core and headline inflation coming in at 0.4% and 0.4%, respectively.

“The recent barrage of hawkish Fed speak proved warranted in light of March’s inflation release suggesting achieving the “last mile” of inflation on the journey to the 2% target is going to prove more challenging than initially perceived considering the 3, and 6-month annualized rate of Core CPI is running at 4.8% and 4%, respectively.

• After experiencing the first positive move higher in core goods inflation since May 2023, the trend of lower goods prices reasserted itself in March with used car pricing reversing last month’s strength coming in at -1.1% which was accurately foreshadowed by the recent decline in used car auction prices.  A return of goods deflation is a welcome development as its been one of the main drivers lower of inflation over the past 18 months
• The problem child continues to be sticky shelter inflation with its biggest component OER coming in at 0.4% on the month.  OER hasn’t had a print lower than 0.4% since August 2021. Shelter inflation has remained sticky even though many private measures of rent growth have been showing declines for a year.  While this gap may eventually close, the bifurcation remains after today’s release.
• Airfares decreased -0.4% in March, partially reversing the largest monthly rise in that subcomponent going back almost 2 years (May 2022).  However, airfares are one of the categories that do not carry from CPI over to the Fed’s preferred core PCE measure as PCE measures airfares from tomorrow’s PPI release.
• Motor vehicle insurance continues to be a source of sustained inflation seeing its largest monthly reading since July 2020 while increasing by +20% over the last 12 months.

The bottom line

Shculze says “The battle between the sticky vs continued disinflationary narratives is moving decidedly toward an inflation backdrop that is plateauing and potentially accelerating.   March’s hot CPI release coupled with last month’s hot jobs data reaffirm that the Fed will remain data dependent requiring more data to feel confident for the commence of the rate cutting cycle.

“This inflation release effectively takes June off the table for the first rate cut and should push the odds out further with a coin toss in July or September.  This release should put upward pressure on 10-year treasury yields along with the broader equity complex as valuations come down,” says Schulze.

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Jeffrey Schulze

Investing and mountain climbing are both judged by the ability to move higher, notes Jeff Schulze, Director and Head of Economic and Market Strategy at ClearBridge Investments, a global investment manager.

“The journey higher is never smooth and experienced climbers understand that heightened concentration is paramount once the crux, the toughest part of a route where the hardest moves and challenges are concentrated, is reached.

“While the consequences of failure in the stock market pale in comparison, we believe the crux for investors lies in the coming quarters as fiscal stimulus and consumer resilience fade while the lagged effects of monetary tightening take hold.

“We worry that many investors have fully embraced the soft landing narrative and are facing potentially the most dangerous part of this cycle’s climb with their guard down,” Schulze says.

In his third quarter market outlook Schulze notes “Any tailwind from higher fiscal spending could be weakened or non-existent should government spending caps go into effect. The other lever to stave off a slowdown, monetary easing, also appears to be off the table as the Fed remains hamstrung by inflation and a tight labor market.

“As supportive macro tailwinds fade, cracks in the economy continue to appear. Consumer balance sheets continue to show increasing signs of strain, with delinquency rates for credit card, auto and other loans on the rise. An economic bull would note that these rates may be normalising from very low levels. However, a pessimist would point out that auto and credit card delinquency rates are already above the peaks seen during the last economic expansion, and student loan delinquencies are poised to rise as the repayment moratorium has expired. Given the challenges consumers are facing, these strains could grow worse in the coming quarters.

“Another crack is evident in the labor market itself. While the economy continues to add jobs, every payroll release this year has been revised lower, and the preliminary benchmark revision last month reduced the March baseline by a further -306,000 jobs. Put differently, 2023 employment growth has not been as strong as initially thought. Large downward revisions to the labor report have historically clustered around economic inflection points, with a similar streak of negative revisions occurring in 2007 in the run-up to the Global Financial Crisis. This data should not set off an immediate recession alarm, but rather is a sign that the labor market may be weaker than perceived.

“We believe the path of the labor market will determine whether the economy continues along the soft landing path or slips into recession.

“Despite headwinds gathering, the Fed appears firmly committed to a higher for longer policy path. This is a shift from the recent, low inflation past when the central bank was quick to deliver accommodative policy at the first sign of macro strain. This is important because history shows the Fed has been instrumental in re-accelerating GDP growth regardless of whether the economy was headed for a soft landing or a recession.

“The economy has never meaningfully picked up until after the Fed started easing,” he says.

Schulze adds “Today, generationally high inflation and a tight labor market leave the Fed hamstrung and likely slower to react to unfavourable data and more targeted when it does. A frozen Fed presents a significant risk to economic growth, elevates the chances of a recession, and could even allow what might have otherwise been a mild recession to metastasize into something worse.

“Unusually narrow market breadth and tepid small cap performance a year removed from recent market lows suggest the current rally could be short lived, leading us to favour growth and defensive equity positioning until more economic clarity emerges.

“In summary, widening cracks across the economy and capital markets could short circuit the current rally. That path should become clearer in the coming quarters as we move through the crux.

“In the meantime, we continue to recommend tilts toward growth and defensive positioning until more clarity emerges on the economic path forward,” he says.

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