Our annual end-of-summer chartbook report traces the labor market deterioration that led us to downgrade equities at the beginning of August. It also highlights the soft-landing expectations that the credit and equity markets are discounting. We like the risk-reward profile of our newly defensive stance.
The market backdrop changed a lot between the preparation and the publication of our equity downgrade report. We publish this companion Insight to help investors navigate the new environment.
Mounting evidence that the labor market is on its way to cracking checked two more boxes on our checklist, driving us to tactically downgrade equities to underweight while upgrading fixed income to overweight. Our tactical and cyclical (6-12 months) views are now aligned as our conviction that a recession will begin before year-end has increased.
It’s status quo for the SIFI banks, as they don’t see consumer credit performance materially worsening from now-normalized levels and they are not meaningfully exposed to commercial real estate losses.
Although we ticked a second box on our checklist, the incoming data still do not indicate that a recession is imminent. We remain tactically equal weight equities with a strong bias to underweight them, but we’re not exiting the party just yet.
Today’s report recaps last week’s webcast and elaborates on its themes, delving into the empirical evidence underpinning our conviction that asset allocators should underweight equities sparingly and fleetingly. We remain tactically neutral and cyclically bearish.
Although the comprehensive economic surprise indexes continued weakening in May, the metrics in our equity downgrade checklist haven’t softened enough to check more boxes now. While we continue to expect the US economy will enter a recession before year end, it is not yet certain and we remain tactically neutral.
The signs of an approaching recession are starting to emerge. We will turn tactically defensive once they all fall into place.
We marked the first X on our Equity Downgrade Checklist and the latest JOLTS, Employment Situation and SLOOS releases brought us closer to ticking some others. We remain tactically neutral on equities but expect that we will underweight them as excess savings are further depleted, leading labor market indicators continue to soften and consumer credit performance continues to fray.