Essentials

Bank Credit Analyst

Bank Credit Analyst

Bank Credit Analyst

In Section I, we explain how recent positive data surprises are connected to expectations of Fed easing, meaning that they are self-limiting. Yields will rise even further if US economic data continue to surprise to the upside, which will put the US back on a recessionary path. A Republican sweep has the potential to be positive for US economic growth over the next year, but trade action under a second Trump presidency will likely be aggressive and economically damaging unless deftly offset by sufficiently large fiscal thrust. In Section II, we explain why the Fed is not politically biased, but has become structurally dovish because of the GFC, its shaken confidence in the “stars”, and its ability to forecast the economy. Over the next year, the Fed may appear to be acting in a politically biased way even if it is merely responding to economic developments. The Fed’s independence could be challenged under a Trump presidency if trade action is not severe.

Bank Credit Analyst

In Section I, we provide an update of our views following the September FOMC meeting and recent announcements from Chinese policymakers. The Fed’s decision this month has modestly increased the odds of a temporary soft-landing outcome. Still, recession remains our base case scenario, and forceful easing also raises the odds that disinflation will end or that inflation will reaccelerate. In China, policymakers are reacting in a panicked fashion to an impending major slowdown. They will likely succeed at preventing that decline, but preventing a further slowdown does not equate to a major acceleration in growth. Stay conservatively positioned. In Section II, we review why real nonresidential fixed investment is unlikely to prevent a US recession.

Bank Credit Analyst

In Section I, we discuss the economic and financial market outlook in the wake of Jerome Powell’s Jackson Hole speech. Equity investors may pursue a bullish rate-cut narrative for a few months, and it is possible that the economic data will remain consistent with a soft landing for a time. However, we recommend selling rather than buying such a rally, given an ongoing decline in labor demand that will ultimately turn recessionary. Investors should remain conservatively positioned. In Section II, we present a list of answers to questions that we have received about our equity portfolio positioning recommendations. We continue to recommend underweighting small caps, overweighting US stocks, and favoring defensive sectors. We are neutral growth versus value for now but expect to downgrade once clear recessionary dynamics emerge.

Bank Credit Analyst

In Section I, we note that the US labor market is turning, and that the economy is indeed slowing to a recessionary tipping point. Disinflation continues, but not at a pace that would allow the Fed to cut aggressively outside of the context of a recession. We continue to expect that Donald Trump will win in November, and trade policy under a second Trump presidency represents a significant risk for investors. We continue to recommend conservative positioning over a 6-12 month time horizon. In Section II, we argue that the Fed should abandon the framework changes that it made in 2020, both to its inflation and employment objectives. If “structural dovishness” is made a permanent feature of Fed policy, investors can expect more frequent booms and busts in financial markets, and higher odds of future inflation overshoots.

Bank Credit Analyst

In Section I, we examine some concerning signs of US economic weakness that emerged in June. We also discuss portfolio positioning in the face of falling interest rates and cross-check our recommended US equity overweight in the face of extremely optimistic expectations about AI’s impact on growth. We conclude that defensive positioning continues to be warranted. In Section II, we dig into those optimistic expectations for AI. We find that the US equity market is significantly overvalued unless the deployment of AI technology causes a 10-to-20 year productivity surge in line with what occurred during the IT revolution of the 1990s, with persistently high margins on the revenue generated from the improvement in growth. We doubt that AI will end up truly boosting economic activity by this magnitude.

Bank Credit Analyst

In Section I, we argue that global investors have been lulled into a false sense of security concerning the resiliency of the US economy. Tight monetary policy means that something must change for a recession to be avoided, and developed market rates cuts will likely be too modest and come too late to save the day. Nimble investors or those highly sensitive to tracking error should not be underweight stocks over the coming 3-6 months. Over a 6-12 month time horizon, we continue to recommend that investors remain underweight global equities versus US$-hedged long-maturity developed market government bonds. Section II is a guest report written by Martin Barnes, BCA’s former Chief Economist. Martin revisits the idea of the Debt Supercycle and discusses how its true end may emerge in response to a fiscal crisis in the US over the coming few years.

Bank Credit Analyst

In a guest authorship of Section I, Doug Peta addresses the recession skepticism often raised by investors. Excess savings are nearly or already drained, labor market indicators remain consistent with an eventual contraction in payroll growth, and there are no signs that credit growth will keep consumer spending afloat. Additionally, this month’s Section II is a guest piece written by Ritika Mankar of BCA’s Global Investment Strategy service. Ritika checks in on the balance sheet health of large, global, listed nonfinancial firms. Firms in the US and Japan appear to be the most resilient in advance of a coming recession, followed by Europe. Chinese firms are the least resilient from a balance sheet perspective.

Bank Credit Analyst

In Section I, we acknowledge that investors may wish to be neutrally positioned toward risky assets even over a 6-12 month time horizon. Our confidence in an eventual recessionary outcome has not changed, but a recession may be delayed by a Fed-driven easing in financial conditions. We are not prepared to change our investment recommendations today, but strong evidence of sustained growth and continued disinflation could lead us to recommend increasing exposure to risky assets for the sake of portfolio risk management. In Section II, we ask whether growth stocks will outperform value stocks during the next US recession. We examine historical performance of style during recessions dating back to 1926, and conclude that growth stocks are likely to underperform value during the next US recession. That assessment will change if growth stocks sell off significantly in advance of a contraction in output, or we see signs of significant sector-specific effects impacting value indexes.