Beyond Bulls & Bears


PODCAST: Anatomy of a recession—Interpreting mixed economic signals

A look at the US economy with a focus on labor, home sales and corporate profits with Jeff Schulze, investment strategist at ClearBridge Investments.

Host: I would really like to discuss the December release of the ClearBridge Recession Risk Dashboard. But before we do, it seems like US Federal Reserve (Fed) Chair Jerome Powell’s speech last week provided some clarity on the next steps for the Fed. Markets reacted positively initially and then it seemed to go in the other direction. Any surprises or thoughts from your point of view?

Jeff Schulze: Well, I think this is obviously a key question. The markets have been reacting positively for quite some time. But I think it was the first time that Powell was back to dovish Powell. We’ve had hawkish Powell, really, since that Jackson Hole conference where Powell ripped up his speech and pushed back on the idea of loosening financial conditions.

But this was the opposite. He wanted to remove any uncertainty on whether or not he was part of the Federal Open Market Committee (FOMC) majority, which was leaning more in the camp of slowing down to see what the lagged effects of Fed tightening has had on the economy, not to overtighten and cause a dramatic recession. So obviously the markets took it as a positive.

And one of the things that the markets were wondering is whether or not the Fed believes in the idea of a soft landing, an idea that I’ve been calling the “immaculate slackening,” which brings down job openings dramatically because they’re about 50% higher than what you saw prior to COVID. If that could happen and create some cooler wage growth, would the Fed be comfortable with that?

And Powell basically said that it’s a very plausible scenario. He doesn’t think it’s a high probability. But if inflation data continues to come down and wage growth cools, the Fed could potentially stop raising rates and pause even though I don’t think rate cuts are forthcoming. And he stressed that he wants to get policy to restrictive and keep it there for a while.

So overall, I think the markets had gotten to peak hawkishness and people were underpositioned because they were expecting a more and more hawkish Fed. And Powell gave some opportunities for the dovishness and the higher expectations for a Fed that’s pausing to come back out. So it certainly was a positive development from a market standpoint and we saw the rally as a consequence.

Host: Understood. Now let’s go to that Recession Risk Dashboard. I recall that with last month’s release, there was some deterioration with the overall signal becoming a deeper red. Have you seen any additional change this month?

Jeff Schulze: Unfortunately, when the dashboard turns red, usually an object in motion stays in motion. And we’ve certainly seen that continue as the dashboard is even further into recession territory. But we only had one indicator change in the month and it was profit margins moving from yellow to red. But profit margins obviously is a really important consideration because usually when you see peak profit margins, it takes about three years to end up in recession.

Profits have been coming under pressure and they peaked about a year ago. But one thing that may keep the recessionary layoff cycle at bay for a little bit is that labor has been the scarcest commodity of this recovery. So corporations may be reluctant to let go of their employees in fear of not being able to get them back should this be a soft landing or a shallow recession. But nonetheless, profit margins have turned to red, and it does bring us potentially closer to a reduction of headcount as we move into next year. Reduction of labor is usually the last domino to fall as you head into a recession.

Host: Jeff, you mentioned labor briefly. I believe this week there were some important employment numbers released. How did that data shake out?

Jeff Schulze: This was a massive week for the labor market. You got initial jobless claims that recently came out, and it moved back down to close to 225,000 per week. So that’s a very healthy number, all things considered. And as a reminder, initial jobless claims is in the Recession Risk Dashboard, usually the last domino to turn red, confirming that a recession has started.

But we’re nowhere close to a red signal with initial jobless claims with the latest release. Also, we got a release on job openings. Job openings moved down to 10.3 million, which was a drop of around 300,000 from the previous month. And although job openings are down from peak levels at 11.9 million, there is still a long way to go, because prior to the pandemic you only had seven million job openings.

So we’re moving in the right direction. But it does give the idea to the immaculate slackening that I mentioned potentially becoming a reality. Now, in thinking about job openings, one thing I like to look at is the number of job openings per unemployed. In normal times, it’s about a one-to-one ratio. We reached a level of two earlier this year, and although job openings have come down, it’s still at a very elevated 1.7.

Prior to the pandemic, that peak was 1.15. So, things are moving in the right direction, but we still need to see more progress. And that’s really a theme that you’re seeing across the labor market. You’re seeing it with the quits rate. Yes, we’re down from highs to 2.6% on the quits rate, but that’s still the highest that you’d ever seen in that data set prior to the pandemic.

Host: How about the small business landscape?

Jeff Schulze: Same thing with number of small businesses that say that job openings are their hardest thing to fill. It’s their number one problem. It’s dropped to 46%. But again, this is a series with the National Federation of Independent Business (NFIB) going back to the early 1970s that had a prior peak of 33%. So, things are cooling, but they’re not cooling enough for the Fed to feel comfortable that wages are coming down, inflation is going back to trend.

And we got the jobs report here recently. Still very healthy print at 263,000 jobs created. But I think most importantly, average hourly earnings still very robust. It came in at 0.6% on a month-over-month basis. If you annualize it, average hourly earnings is running at a 7% clip, which is consistent with the other two major measures of wage growth.

So, yes, it was a big week for the labor market and continues to show that the labor market is maybe the economic Kevlar for this expansion. But I firmly believe that it may ultimately be the Achilles heel of this recovery, because the Fed may have to push harder in order to get its slack and slower wage growth and potentially lower inflation.

Host: So, the news on the employment front regarding inflation and rate hikes does not sound good. Home sales also seem to grabbing a lot of headlines of late as well. Anything of note on this particular topic?

Jeff Schulze: Housing’s in a recession. I’m going to put it bluntly, there’s no other way to look at it. You saw home prices fall on a month-over-month basis for the third month in a row, housing starts, housing permits have been moving down pretty dramatically. The homebuilder survey, the National Association of Home Builders (NAHB), is at a 33 level. That is a very deeply negative reading.

And this is really important because the NAHB actually leads the unemployment rate by 12 months, which would suggest a lot more people laid off as we move into 2023. There’s an old adage out there. As housing goes, so does the US economy. Housing is the most interest-rate sensitive part of the economy.

So it’s not a surprise given how aggressive the Fed has been in raising rates, that you’re seeing some weakness here. But good news, this should not be a recession that we saw in housing in 2008 to 2016. Credit standards have been conservative. People have been given mortgages with very high credit scores.

There’s been very strong down payments. Over 90% of mortgages are fixed. So, yes, mortgage rates have doubled. Affordability is hurt. But it’s really only hurting the 10% of Americans that have an adjustable-rate mortgage and someone who has newly purchased a home. So, it’s certainly going to hurt economic activity, but I don’t think it’s going to have nearly the effect that we saw just 15 years ago with the global financial crisis.

Host: Another phrase that I’ve seen and heard used with great frequency is mixed economic signals. Is that a fair assessment of the current environment as we track all the pertinent data?

Jeff Schulze: That is very true today. And it usually is at key economic inflection points. I think we’re in the environment where it’s one step forward, two steps back. That’s why I think we’re going to see a choppy environment with equities, because the data is going to be inconsistent as the lagged effects of monetary tightening bump up into a pretty resilient consumer and resilient spending.

We talked about the labor market. There’s really no weakness to point to at all in the labor market. And this maybe the tightest labor market, quite frankly, we’ve seen in five decades. So it’s going to take a long time for that domino to fall over. Retail sales was very robust in the latest release that we got.

So, people are still tapping into those excess savings that were accumulated over the course of the pandemic. But on the other end of the equation, housing is weakening very fast. It’s in a recession right now. So, you’re going to see this bifurcated data release, I think, really up until the second quarter of next year, and it’s going to create an environment where we’re going to have these pockets of strength in the markets and then pockets of weakness until the ultimate path is revealed on the US economy. But I think this inconsistent data environment is going to continue for at least the next couple of months.

Host: I almost forgot to ask you about inflation. I understand it’s embedded in all of your other comments. But is there anything specific, maybe a date that you’ve earmarked from a key data point?

Jeff Schulze: Well, inflation, obviously, is the keyword that puts all of this together. It’s the key in the Fed tightening process. It’s a key to the health of this expansion and the longevity of it. And I really have December 13th earmarked on my calendar as a huge day for the direction of the markets in the economy. That’s when we get the next Consumer Price Index (CPI) release.

Consensus expects both headline and core CPI to come in at 0.3% on a month-over-month basis. And it’s going to be important to see whether or not we can have the follow-through on the weak CPI print that you saw from October, which was the best piece of news that you’ve seen on the inflation front really in over a year.

You saw a broad-based slowdown in inflationary pressures in areas that were expected, like used cars, like medical care services. But you saw large declines in areas that were unexpected, like shelter inflation. There are signs that we’re seeing peak shelter inflation, but it’s probably going to be moving down based on some of the forward-looking measures that we’re seeing for rents, but also goods inflation was actually pretty broad-based in decline as supply chains get fixed and people transition over to services.

So I think that’s going to be a key data point. And I think, more importantly, that comes the day before we get the next FOMC meeting for December, which is obviously going to set the stage for the path for the Fed and whether or not they need to do more to feel comfortable bringing inflation down to target.

So more to come on that front. But it will be interesting to see if we can see a follow-through on that weak print from October.

Host: It certainly sounds like December will be a big month with another CPI print and the FOMC meeting taking place mid-month. Do you have any final thoughts for our listeners?

Jeff Schulze: Yeah, I think it’s important to just remember to have some patience. This is the first proper recessionary drawdown that we’ve had to endure in 15 years given how quick COVID’s recession was, but also the response by monetary and fiscal authorities. They never know the depth and the timing of a recession. And they had the keys in the last recession to be able to calibrate the proper policy response.

So, this is going to be a marathon rather than a sprint. It’s going to be filled with starts and stops. But I think we are reaching a point where it’s good to start thinking about allocating money into equities as we try to anticipate the recovery that may take place in later 2023 and early 2024.

And if you look at every bear market since 1940, if you had bought the day you went into bear market territory, yes, the markets go down another 15% in general. But even with that near-term weakness, six months out, the markets are up 4.1% on average, 12 months out, the markets are up over 11% on average. And we went into bear market territory over five months ago.

So, it’s probably a good time to start thinking about increasing your equity exposure, even though we’re expecting some choppiness and maybe even more downward pressure over the next quarter.

Host:  Thank you, Jeff, for your terrific insight as we navigate the markets.

Jeff Schulze:  Thank you.

Host:  You can prepare yourself by reviewing Jeff’s monthly commentaries and checking out the dashboard at Again, that’s Once again, today’s guest was Jeff Schulze, the architect of the Anatomy of a Recession program.

If you’d like to hear more Talking Markets with Franklin Templeton, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify or just about anywhere else you get your podcasts. Thank you all for joining Talking Markets.


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