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Investment outlook
The economy and markets
Section 3: The economy and markets
Key points to know
The home stretch can be a winner
Unlike a typical contest of speed, the economic race against recession has no pre-determined finish line. The shortest expansion in post-war U.S. history lasted just 12 months, from 1980 to 1981. The expansion that ended with the pandemic recession lasted a record 128 months. Since the last recession in April 2020, the U.S. economy has raced forward at an impressive pace. Spectators should now ask: Is the finish line approaching or is there ample runway? And what should we do about it?
We think a mild recession in 2025 is the base case for the U.S. and global economies. That means we’re in the final stretch of the expansion, but it’s still too early for investors to position aggressively for a risk-off scenario. Historically, equity markets have rallied until just two months before the onset of recession (Figure 2). While the economy is likely in the home stretch, the current macro environment warrants a healthy degree of risk exposure.
Labor market cracks are deepening
As tight policy continues to bite, U.S. labor market cracks grow deeper and wider. Already, the pace of job creation has dropped below its pre-Covid trend, with unemployment also ticking higher. Part of the increase is due to positive, supply side dynamics, with prime-age labor force participation touching its highest level in more than 20 years. But it also reflects a negative deterioration in demand for labor. Hiring has slowed, and more people are spending longer periods of time unemployed. Some of the best leading indicators for future labor market conditions have softened, including the number of job openings and the rate at which people voluntarily leave their jobs. We expect unemployment to move higher in the quarters ahead, weighing on overall growth.
Moving past inflation fears
Overall core inflation is approaching the Fed’s 2% target on a three-month annualized basis due to several dynamics. First, tight policy has put loosening pressure on the labor market. Wage inflation peaked around a 6% annualized rate and has now declined to around 4%, leading to softer core services prices. Second, though housing continues to run at an above-target pace, it has moderated substantially during this year, and leading indicators point to further improvements. Third, global growth has softened overall, with Europe expanding around 0.5% year-over-year and China posting its weakest growth since the 1990s (excluding the Covid-era lockdown). Finally, while geopolitical concerns remain a risk, they have not escalated in recent months, allowing global shipping prices to quietly drop around 40% from their December peak.
While the economy is likely in the home stretch, the current macro environment warrants a healthy degree of risk exposure.
A gradual, not rapid move for the Fed
With growth softening, inflation approaching target and recession risks rising, it makes sense that the Fed started cutting interest rates. However, markets may be too optimistic about future rate cuts, even after the strong 50 bps cut to start the cycle. Fed officials have indicated a preference to move steadily, which means they will likely cut 25 bps per meeting, while retaining the flexibility to accelerate or pause cuts. This allows time to gauge the impact of rate cuts as the central bank moves toward a neutral policy stance of around 3.25% to 3.50%. We expect the Fed to eventually get back to that level in the middle of next year.
All market and economic data from Bloomberg, FactSet and Morningstar.
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Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Performance data shown represents past performance and does not predict or guarantee future results. Investing involves risk; principal loss is possible.
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Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy. Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well.
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