US Labor Market

In Section II, Jonathan shows how valuation-adjusted fundamental momentum has been a successful tool for ranking global sectors.

US GDP growth appears to have accelerated even as employment growth has faltered. We will make a final decision in early October when we publish our next Strategy Outlook, but most likely, we will cut our 12-month US recession probability to 40%-to-50% from 60% and turn tactically neutral on stocks, while still retaining a modest equity underweight over a 12-month horizon.

While it is impossible to know exactly when global equities will peak, there are now enough vulnerabilities to justify keeping one’s finger near the eject button.

High US inflation is being driven by tariffs, not domestic inflationary pressure. This argues for Fed easing and a bull-steepening of the Treasury curve.

For the next few months at least, inflation risk trumps recession risk for both US markets and world markets. This because, correctly gauged, the US jobs market is still supply-constrained with ‘jobs looking for a worker’ exceeding ‘workers looking for a job’ by 0.4 percent. A still supply-constrained US jobs market cannot enter a demand-driven recession until it flips back to demand-constrained, so bond investors should underweight duration. Plus: a new tactical trade is overweight India (INDA).

Although our recession conviction has risen, we conclude our strategy review by closing our equity underweight and our fixed income and cash overweights. AI momentum is too strong to have anything more than modest exposure to an equity decline via a small SPY put position.

The August employment report showed a modest increase in labor market slack, enough to cement a 25-basis-point rate cut this month.

Economic activity plainly slowed in the first half, led by decelerating consumption and payrolls growth, but financial markets didn’t care. If the next two weeks of data don’t indicate that the May-June slowdown stretched into July and August, we will likely drop our defensive recommendations.

Data received since we began reassessing our bearish stance supported our notion that the economy is not as strong as the investor consensus perceives. But the softness will likely have to intensify in July and August to preserve our defensive recommendations.

Economic activity and hiring cooled significantly in the first half of the year. The most important question for investors is whether this signals an imminent increase in labor market slack.