ClearBridge lowers recession risk indicator

ClearBridge Investments has downgraded several of its recession risk indicators after an improvement in key figures in the last six months.

The overall dashboard has improved from red (recession likely) to yellow (caution), with improvements in five underlying indicators including housing permits, retail sales, ISM new orders, commodities and credit spreads.

“As we progress from a (hopefully) once-in-a-lifetime global pandemic, it has become clear that there are more differences between the current economic expansion and historical patterns than previously perceived,” Jeffrey Schulze, Director and Head of Economic and Market Strategy at ClearBridge Investments, said.

“These divergences have driven an incredibly robust economy over the past two years despite many normally reliable recessionary indicators pointing to an impending downturn.

“While we remain wary of becoming complacent given numerous risks that abound, the current cycle stands out given the improvement of several leading macroeconomic indicators over the last six months.”

Schulze said given the easing of multiple indicators over the last six months, investors should turn their focus to areas of recent relative underperformance such as the S&P 493 and small caps.

“One such measure comes from the housing market, which typically moves in tandem with the economy but appears to have decoupled since the pandemic — an unusual dynamic that has only occurred twice before in the 1960s and the mid-1990s.

“An additional leading indicator showing recent improvement is the Federal Reserve’s quarterly Senior Loan Officer Opinion Survey (SLOOS), which is showing meaningfully less tightening in lending standards for both commercial and industrial (C&I) and commercial real estate (CRE) loans.

“Another key economic difference relative to history has been the role of fiscal stimulus. Typically, budget deficits decrease as the economy expands, needing less support, while policymakers deliver stimulus during tougher times often accompanied by rising unemployment. However, the paradigm appears to have shifted around the midpoint of the last economic cycle.”

Schulze also warned investors of buying into the hype surrounding the ‘Magnificent Seven’ group of tech stocks, which – despite their “super earnings growth” recently – are expected to fall back toward the market average over the next two years, signalling a potential return to broader market participation and easing of concentration.

“One development that bodes well for the health of the rally is that the ‘Magnificent Seven’ stocks are trading less as a monolith than they did in 2023 — a sign the market is refocusing on fundamentals. In fact, three of the seven members lagged the S&P 500 Index in the first quarter, with two of them suffering losses. Investors who can discern what has been embedded into these stocks and whether earnings will come through to justify current valuations will clesarly benefit from this.

“Long-term investors should take some comfort from the fact that the S&P 500 achieved its first new all-time high in over a year in January, along with several more during the course of the quarter.

“With economic indicators continuing to improve and recession risks further ebbing, we believe investors would be best served by focusing on areas of recent relative underperformance such as the S&P 493 and small caps, segments where improving earnings outlooks and less stretched valuations could fuel upside in a soft-landing scenario.”