US recession still possible

Despite improving economic sentiment leaning the consensus view toward a soft landing, ClearBridge Investments believes a recession in the US is still possible, with the expected horizon between mid-2023 and mid-2024.

The manager said a resilient equity market had a checkered history in correctly sniffing out a recession and the market had delivered a positive return 42% of the time in the six months prior to the start of a recession and been positive 25% of the time in the three months prior.

Jeffrey Schulze, Head of Economic and Market Strategy at ClearBridge Investments, stressed that monetary policy only became restrictive in late 2022 and, according to him, economists and strategists might be premature in “declaring ‘all-clear’” as the lagged effects of monetary policy could begin to truly slow economic growth in the coming quarters.

“Considering a typical policy lag of six to 18 months and the timeline from initial rate hike to contraction, the horizon for a recession could be between mid-2023 and mid-2024,” he said.

“History also suggests it may still be too early in the hiking cycle to expect a recession, even though it may feel like the Fed has been in tightening mode for an eternity.”

He noted that historically a recession started 23 months after the first increase of a persistent hiking cycle and only three of the last 12 persistent hiking cycles (since the late 1950s) saw a recession begin by this point.

“Given how far behind the curve the Fed was coming into this hiking cycle with nearly double-digit inflation and federal-funds rate starting at 0%, it is understandable that recession headwinds need more time to coalesce,” Schulze added.

According to ClearBridge, investors misguidedly started to embrace a soft landing.

“This juxtaposition moderately reinforces our view that a recession is the more likely outcome over the next year given that sentiment measures typically work best as contra signals. In fact, with the benefit of hindsight, this was the case coming into the year, with everyone expecting the “Most Anticipated Recession Ever,” the manager said.

“Whether our view ultimately proves correct, it is based on our process and a set of indicators that have historically been effective in anticipating the onset of a recession. While much less anticipated by the consensus than eight months ago, we continue to believe a recession is on the horizon.”