Host: Welcome to Talking Markets with Franklin Templeton. We’re here in the studio this afternoon with ClearBridge Investments’ Head of Economic and Market Strategy, Jeff Schulze. ClearBridge is a specialist investment manager of Franklin Templeton, and Jeff is the architect of the Anatomy of a Recession Program, a program designed to provide you with a thoughtful perspective on the state of the US economy. Jeff, it’s great to have you in the studio. Let’s get right to it.
I’d like to talk about the ClearBridge Recession Risk Dashboard. Have there been any changes with the January release?
Jeff Schulze: Well, yes. There has been one upgrade that we saw last month with Manufacturing PMI going from red to yellow. And, as a reminder to everybody, we look at the “New Orders” subcomponent of that survey, because it tends to have leading properties. And it jumped from 47 up to a very healthy 52.5, which is in expansion territory. So, this is a really good development for the prospects of the manufacturing sector. And, at the moment, out of the 12 indicators that we have on the Dashboard, six are red, six are yellow, and we have zero green signals. But we’re getting very close to an overall yellow signal.
Also, the other thing I’ll mention is that we do look at other “soft surveys” in the Dashboard. Soft surveys are more like sentiment surveys. And the Conference Board’s Consumer Confidence Index is something that we look at. And we’re looking specifically at “Job Sentiment,” which looks at the number of people that are saying that jobs are plentiful minus those that say that jobs are hard to get. And it jumped by a really healthy 8.4 points to an overall level of 35.7. So that’s one indicator as we look out on the horizon that’s on the border of potentially going to yellow and may tip the overall dashboard into yellow cautionary territory. But, nonetheless, this is a very good development, and it increases the prospects of a potential soft landing.
Host: Jeff, you just mentioned jobs. The January jobs report was recently released. It came out with more than double the consensus expectations at north of 353,000 jobs created. What are the key takeaways in that report from your point of view?
Jeff Schulze: Well, if I had to sum it up in one word, it would be “Whoa!” What a hot jobs report, a strong jobs report. Double consensus expectations. And it was above the highest estimate out there of 300,000, so nobody was anticipating a jobs report of this magnitude. And I think a couple of the worrying signs that we’ve talked about have been alleviated.
The first one is that we’re concerned about the negative trend of payroll revisions that you were seeing in the releases. And prior to the release that we just got, 10 out of the 11 prior months had their initial jobs release revised lower. Usually, you see this when you’re going into a recession. And, prior to the release, over the last 12 months, you had negative job revisions of 427,000. And usually if it’s just below zero, you’re in a heightened recessionary territory. Now, the good news is, with this release you had an annual restatement of the last 12 months’ data. And instead of those negative revisions being -427,000, it’s dropped to a -84,000. So, to put that differently, the labor market is a lot healthier than what we had thought just a month ago.
The other worrying sign that we saw some progress on is temporary worker employment. We saw the first positive print here since February of 2023. And temporary workers are a leading labor indicator. And what I mean by that is usually you’ll see temporary worker trends move down before layoffs actually materialize, because employers are trying to cut costs by letting go of low-hanging fruit like temporary workers. Because if you let go of a full-time employee, if you need that individual back, very expensive proposition to find someone and then retrain them to get them to where they need to be. So, to see temporary workers finally come in positive is an encouraging sign.
Host: So very positive, very encouraging signs. Is there anything else in that report that may still have you concerned?
Jeff Schulze: Well, it’s not all rainbows and sunshine. There were a couple of warts that are kind of still out there that need to be resolved.
The first one is that average weekly hours fell to a new cycle low of 34.1 hours in a given work week. You know, similar to temporary worker trends, this is a leading labor metric, because, again, in cutting back temporary workers, usually they’ll cut back hours worked as well as a way to preserve margins before a layoff cycle begins. Now, this could be distorted potentially because of bad weather. The reason that’s the case is that when you have bad weather, it’s much more likely to impact hourly workers, and it takes them out of the wage equation and then skews it more toward higher-end workers. That may be a reason why the average weekly hours fell and why wages had spiked during this month as well.
The other thing that has us still concerned is the household survey. On jobs day, you get two releases. You have the establishment survey, which is where we get that headline jobs number. And that comes from data that businesses are providing to the government. And then you have the household survey, where that’s data that is retrieved from individual households and what their view on the labor conditions were for the previous month. And when you look at the household survey on an apples-to-apples basis to the establishment survey, it came in at -450,000 jobs. You compare that to positive 353,000, which was the headline number, a really big differential. And, in fact, if you look over the last year, the household survey has come in less than 150,000 jobs per month lower than the establishment survey. So this is a divergence that bears watching, because usually the household survey has been historically more accurate at key inflection points. And I think that the takeaway is that the job growth that we’re seeing today may be less impressive than it currently appears.
So overall, a really strong jobs report. Again, this increases the odds of a potential soft landing, but there’s still a couple other things out there that we need to get a resolution on.
Host: So what does this mean for the Federal Reserve [Fed] and the start of its potential cutting cycle?
Jeff Schulze: Well, it pushes it back, right? The Fed had an FOMC meeting earlier this week, and a lot of people were saying the Fed was hawkish. I would say that the Fed was being more conservative, more cautious. They liked the data. They just wanted to see more data come out before moving into a cutting cycle.
But I think, importantly, even though a weakening labor market wasn’t a necessary condition for a cutting cycle, they needed to see continued soft wage readings. And with average hourly earnings coming in at 0.6% on a month-over-month basis, which is the strongest that you’ve seen since March 2022, this is going to raise fresh concern with the Fed about the potential for a reacceleration of inflation. So if you look at fed funds futures for 2024, instead of six cuts, now they’re pricing in five cuts. And this certainly pushes out the cutting cycle to the earliest in May.
Host: So how about the potential implications for investors?
Jeff Schulze: Well, we’ve been in a regime where higher 10-year Treasury yields has meant lower equities. And I guess the key question here is whether or not that’s still going to be the case with the 10-year Treasury spiking almost 20 basis points, you know, the day of the jobs report. And while that certainly could continue, historically what has mattered most for equities is the growth picture. Usually when you have higher 10-year Treasuries (higher yields), that’s associated with stronger economic momentum and activity and better earnings growth. So this environment that we’ve been in, where higher 10-year Treasuries has meant lower equities, is actually relatively new. And it’s not the normal course of action.
So, if a soft landing does ultimately materialize, I think although higher 10-year Treasuries could put pressure on the P/E [price/earnings], or the multiple, that is embedded into equities, I think better growth expectations could negate some of that headwind, at least much more so than what we saw in 2023.
Host: So, Jeff, when people think about the overall state of the health of corporate America, they think earnings. Of late it’s been about big tech. Is big tech still the standout for investors looking for value?
Jeff Schulze: Well, it’s been a mixed bag with big tech, but nonetheless they are hitting their earnings expectations. And a lot of tech has been rewarded. But I think it’s important to note that we’re about two-thirds of the way through the reporting season right now. Seventy percent of companies have been beating estimates by close to 7%, which is historically a pretty solid quarter.1 But I think a lot of people forget the fact that expectations have come down dramatically since January 1 and even more so since October 1.
And to maybe put some color around that, technology is the only sector where earnings growth is greater than what was estimated on October 1.2 And utilities, communications and industrials are the only three sectors where sales growth estimates are actually ahead of where we were just four months ago. So this has been kind of a lower bar, if you will. And if you look at the price action with companies that have missed on both the top and bottom, which is sales and earnings, they’re seeing a much larger than normal penalty with their share prices. But with companies that are beating on both the top and bottom, they’re only being rewarded about half of their long-term average. So this tells us that there’s pretty high expectations that were baked into stock prices already. Even though we’re clearing this low bar, you’re going to need to see more for equities to durably move higher with this earnings season.
Host: How about the “Magnificent Seven” stocks: so Apple, Microsoft, Meta, Nvidia, Tesla, Google and Amazon? Will they continue to outperform here in ‘24?
Jeff Schulze: Well, that’s the question everybody has on their mind. And I think as we move through this fourth quarter earnings season, it’s become clear that maybe they shouldn’t be viewed as a group anymore, and you’re going to start to see some individual divergence with the prospects of these companies.
Tesla obviously has been a big underperformer since they released their earnings. Microsoft has seen some weakness. Google was traded pretty heavily defensively post earnings. And then you’ve had some positive notes like Amazon and Meta here recently. So, while I think the Magnificent Seven stocks will do okay, I think as a group they’re going to underperform. And I really think that this is an opportunity to be able to sidestep some of that concentration risk that you have in the S&P 500 [Index] and embrace active managers that can assess realistically whether or not these heightened expectations that are embedded into each one of these individual stocks is attainable and be able to underweight or overweight that appropriately.
And I think the performance that we saw from the October 27 lows last year through the end of the year, where you saw the Russell 2000, the Russell MidCap Index, the S&P 493 and the Russell 1000 Value really performing either better or right in line with the Magnificent Seven—I think that those are areas of potential opportunity if we have a soft landing and growth becomes less scarce and it broadens out to these cohorts that have lagged the Magnificent Seven as a group, quite frankly, since the beginning of 2023.
Host: So, Jeff, you just mentioned opportunities that may exist. The S&P 500 recently hit all-time highs. Is that a good or bad thing from your perspective, maybe with some historical backdrop?
Jeff Schulze: I think investors’ knee-jerk reaction is that it’s a bad thing, right?
But it’s actually a really good thing when you haven’t had an all-time high in over a year and you finally attain one. And this is relevant because the S&P 500 just had its first all-time high in over two years, just a couple of weeks ago. So, when you’ve had a new all-time high following a year pause without one (this has happened 14 times in the S&P 500 since 1954), importantly, if you look a year after attaining that new all-time high, the S&P was up 13 out of 14 of those instances with an average return of 13.9%.3 Now, I will say that this isn’t foolproof, that strength begets strength, because the one negative instance happened in May 2007, which of course was right before the global financial crisis. But history suggests that you have an all-time high, especially one that hasn’t been attained for a long period of time, usually that forward momentum will continue with you.
And, you know, we actually ran an analysis of two hypothetical investors going back to 1950. And each one of these investors get $1,000 to invest each year. And the first investor invests their $1,000 on January 1 in one-year T-bills. And the second investor invests that $1,000 each year in the S&P 500. But this individual has the worst timing ever. They had to invest that $1,000 on the market high for the year in the S&P 500. And over the course of 73 years, $73,000 invested, that T-bill investor today has $449,000. But that individual with the worst luck, investing at the highs each year for the S&P 500, has $2.795 million, so $2.8 million. So [it] tells you that yes, even though the markets are at all-time highs or near, it doesn’t necessarily mean that it’s a bad time from an investment perspective.
Host: Jeff, any final thoughts that you’d like to share with our listeners?
Jeff Schulze: Look, I think the markets are pricing in a lot of optimism right now. Even in a soft-landing scenario, I could see some choppiness as we have a digestion period. But also, I want to remind everybody that we’re maybe not out of the woods quite yet from a recession standpoint, because although everything is pointing to a soft landing and we have increased our odds of that, you still have historical precedent, and you still need to deal with the traditional lags of monetary policy.
And if you go back to 1958 and you look at all the persistent hiking cycles that began within three-and-a-half years of a recession, which is where I think we are today, the average length of time between that first rate hike and the start of a recession was 23 months.4 And we’re just coming up on 23 months in the middle part of February. So we’re kind of right in the middle of when that lag tends to bite economic activity.
But the one thing I’ll mention, and what we’re watching for very closely, is whether or not we can get more stimulus out of Congress. Right now, you have the potential Wyden-Smith proposal that, if it moves forward, would put about $140 billion of tax revenues into corporations. And it’s going to be retroactive to 2022.
But we also have the Employee Retention tax credit payouts, which is estimated to be around $140 billion as well, that the IRS [Internal Revenue Service] may start to process those claims again sometime in the second quarter. And a lot of that money is going to be going to small businesses as opposed to the previous potential stimulus going to larger corporations. So, if corporations in general are getting almost 1% of GDP [gross domestic product] in potential payouts, that could go a long way to padding their profit margins and creating a situation that, even if they were struggling prior to those payouts, they may hold on to their employees and may further increase the prospects of a potential soft landing. So, this is one thing that we’re watching very closely as we move through the next two quarters.
Host: Very interesting, Jeff, and probably a great topic for our next conversation. Thank you, Jeff, for your terrific insight today as we continue to navigate the capital markets here in 2024.
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1. Source: UBS, February 2, 2024.
2. Source: Strategas, January 30, 2024.
3. Sources: FactSet, S&P. Data as of December 31, 2023.
4. Sources: FactSet, Federal Reserve.