In the last two quarters the US labour market has softened considerably. In contradiction to labour market weakness are contemporaneous measures of US GDP. This shows a US economy reaccelerating. A divergence between labour force growth and GDP growth is unusual and was not expected.
The pulse of the global economy has slowed. Soft data is weak, and hard data is softening. Earnings revisions are lower, equity markets are higher, with valuations extreme.
In this quarterly we review the US economy and the sagging US consumer. We put US housing construction employment in the spotlight and highlight the role homebuilder profit margins have played in confounding employment expectations. We then transpose this analysis to the broader economy.
In doing so, we reduce the chance of a recession occurring in the US to c.50% in the next 12months. The alternative is likely to be sub-trend growth with a risk of increased inflation.
Should the US economy fall into recession, the global economy is likely to follow suit.
Don’t ‘buy the dip’. Even after the recent pullback, equity valuations remain expensive. US double digit earnings growth expectations for 2025 look vulnerable. If 2025 delivers flat earnings, and valuations normalise, the S&P 500 could fall a further 25%.
Soft data (consumer sentiment, business intentions, survey results) have all rapidly deteriorated in the US. Hard data, being more consequential, remains on firmer footing. One cannot rule out a US recession having commenced in March/April, but until hard data emerges to corroborate it, I wouldn’t ‘bet the house on it’.
The US economy, particularly the labour market, was not strong entering 2025. Weaker economies are vulnerable to shocks. Trump policies, even though he campaigned on them, are providing a shock. This quarterly attenuates market noise, exploring the structural drivers of the post-GFC business cycle.
We then zoom in on real time business cycle indicators. Our caution at the end of 2024, and commencing 2025, is no longer out of consensus.
For about 2 years, we have expressed a view that US recession risks were low until late 2024 or early 2025. We are now amidst this period where interest rates remain restrictive whilst economic insulation has largely been exhausted.
The irony of market optimism over the last quarter is the rapid tightening of financial conditions it has produced. Financial conditions are around the tightest they have been since the eve of the GFC. We explore what this might mean for 2025 in our quarterly. We aren't trying to make a forecast, but we are trying to characterise risk.
For 2025, the best offense might just be a good defense
A volatile quarter, with markets at all-time highs, whilst leading indicators remain weak. Unusually, a super-sized rate cut from the Fed, in the absence of a crisis, can be read in one of two ways:
A commitment to achieving a soft-landing
Deepening concerns of weakness in the labour market
This quarterly unpacks:
The volatile quarter that was
China's economic malaise
A run through of leading US labour market indicators
The case for a soft-landing
A focus on Australia and the outsized role of Government spending
Investment comments and positioning.
Please reach out with any questions or comments.
With upside inflation risk lower, and interest rates restrictive, recession risk for late 2024 or early 2025 has increased. The c.55% recession probability from our last quarterly has grown to c.70%.
In the event of recession, Monetary Policy has the ammunition to respond. Investors who protect capital leading into the next recession, should be prepared to pivot when opportunities arise.
The probability of recession arising, and inflation re-accelerating have both being revised up, discussed in full within our economic update. This quarter we also take a walk down memory lane, looking at similarities to 1948 and offer up some killer dinner party conversation fodder... the 'kinked Phillips curve' framework, in our deep dive into labour markets.
The final quarter of 2023 saw markets firm on a soft landing outcome, with a rally in equities and a pricing of interest rate cuts in 2024. Disinflationary forces have seen Central Banks make remarkable progress in returning inflation back towards target. Might this be the goldilocks outcome Central Bankers hoped for and #markets thought impossible just 12 months ago?
This Quarterly discusses the two competing economic scenarios and the key data points that help inform our views on the outlook for 2024. We finish off with a run down on investment positioning, pockets of potential value and our favourite graph from 2023.
