In our last commentary, we highlighted the changing macroeconomic environment and the risks to the current bull market. As a result, we de-risked our portfolios at the beginning of April. As of this writing, risk assets are roughly at the same levels. While markets bounced back in May, the short-term action does not change our view on the asymmetric risk we believe markets will face in the second half of the year. We believe there are several factors within our decision-making process that highlight these risks.

First, let’s review our golden rule of investing: “stay bullish on risk assets unless you have good reason to think that a recession is imminent”. While this oversimplifies our asset allocation process, it is the north star of all macroeconomic analysis, as equity markets and recessions go hand in hand. The catch is, of course, that it is difficult to know whether a downturn is lurking around the corner. We believe there are several “good reasons” to expect a mild recession in the back half of 2024 or early 2025.

The first is that the US labor market is set to weaken abruptly. While Covid and its aftermath have distorted unemployment data, the number of job openings in the US has declined from a peak of 12.2 million in March 2022 to 8.5 million in March 2024. Alternative private-sector sources on job openings such as Indeed and LinkUp tell a similar story. (Chart 1)

If job openings continue to trend lower, they will fall below where they were in 2019 by the end of 2024 or early 2025. At that point, the unemployment rate – which has already risen 0.5 percentage points from its lows – could start rising quickly.

Just as water can abruptly turn into ice if the temperature falls far enough, the economy can also freeze over if job openings fall far enough.

This catalyst could cause ripple effects that push the savings rate higher and lower consumption in the economy. And consumer balance sheets are already wearing thin: Consumer credit growth has come off the boil; Credit card delinquencies are already back to where they were in 2012 (when the unemployment rate was 8%). This has prompted banks to tighten lending standards and raise credit card rates to the highest rates in history. A rise in unemployment would exacerbate these issues and breed financial instability. (Chart 2)

Investor’s confidence in a “soft landing” has powered gains across risk assets. It is fully priced into asset markets as the AI boom, crypto, and other speculative assets continue higher. However, this is very on brand for stocks to melt up into a hard landing. Just as investors start piling into stocks because of the “fear of missing out” on returns. While we believe a recession has likely been delayed, we do not think a harder landing is properly priced into asset markets. The economy is still digesting the effects of lagging monetary policy.

While there is scope for economic data and corporate earnings to remain resilient over the near-term and continue to support equities over a tactical investment horizon, we doubt that this resilience can be sustained over the longer term. Moreover, stock prices and valuations suggest that equities are not priced for recession, making them more vulnerable to the downside in the event of an economic downturn. Even a valuation reset back to the average of the last decade would trigger a 20% decline in indices.

Financial stability breeds instability. Stability encourages more leverage, which plants the seeds of potential squeezes and brutal collapses. We believe there are elevated odds of a mild global recession in the next 12 months, and it will eventually weigh on the price of risk assets.

This month, we did not make any changes. We maintain our underweight positioning to risk assets. We will continue to adapt as the facts change, which includes more defensive positioning if our belief in recession strengthens. We believe tactical asset allocation is now more important than ever.

Recent Portfolio Changes

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