Beyond Bulls & Bears


Podcast: Anatomy of a Recession: Expecting an Economic Boom

Jeff Schulze, investment strategist at ClearBridge Investments, a specialist investment manager of Franklin Templeton, discusses why expectations for gross domestic product growth in the United States are soaring, how high the 10-year Treasury could rise, and why not to fear inflation long term.

Hear more in our latest “Talking Markets” Podcast. A transcript follows.


Host: Jeff, let’s start by looking back to the beginning of the year, where your view of economic growth was above the consensus view. Now, here we are in the second quarter; how do you see the remainder of the year playing out?

Jeff Schulze: Well as a strategist, you always feel a little uncomfortable being well above or well below consensus with a market or economic call. And I was well ahead of consensus with my expectation for real GDP growth this year in the US at 6%, while consensus was closer to 4%. But after a strong first quarter and a larger-than-anticipated fiscal package, consensus has moved much closer to 6%, but I’ve ratcheted my expectations up a little bit because the stimulus package was bigger than I anticipated. So, I’m thinking 7% instead of 6% GDP growth this year. And you’re going to see an explosion of economic activity over the next couple of quarters, and the key catalyst is the $422 billion that just went out to consumers with that March stimulus package.

To put that number in context, back in January, consumers received $130 billion in refund checks from the December package. That supercharged January’s retail sales numbers at a positive 5% month over month. That’s a blockbuster number, and this number that we got right here is 2-½ times that check size. So, I’m expecting retail sales for March, potentially for April, really going to supercharge economic growth over the next couple of quarters.

And if you think about the stimulus that has been done here in the US, it’s been about $5.3 trillion over the last 12 months, or 25% of GDP. If you look at the increase of the budget deficit as a percentage of GDP, the stimulus that was seen over the last year is more than the last five recessions combined. You’ve seen $43,000 per household put out in stimulus in the US economy. This number is actually more than it cost to fight the entirety of World War II in today’s dollars. So, it’s a huge amount of money, and there’s actually more fiscal support for the economy this year than last year after the March fiscal stimulus package that passed.

So, you have a lot of momentum heading into the second quarter here, and, because of all this, I think you’re going to see some blockbuster growth and much faster jobs recovery this cycle than last cycle, because out of the 9.5 million jobs lost because of COVID-19, 75% of them are in COVID-sensitive industries. And when you see a re-engagement with the services side of the economy, as we reach herd immunity, you’re going to see much faster job creation. And in March, you had 916,000 jobs created. I would not be surprised if you see one million plus jobs created in the subsequent months as we reopen.

Host: Alright, let’s turn to interest rates. We’ve seen a dramatic move to the upside recently. Back in January, you had a strong view on rates. Can you provide your current view, and address how they fit into the rally in equities?

Jeff Schulze: Again, I was really optimistic versus consensus on the 10-year [US] Treasury because of that optimistic growth backdrop that I just talked about. I was expecting 1.75% at year end, and at the beginning of the year, only four out of 58 sell-side forecasts were at this level. However, after the big move that you’ve seen in rates in the first quarter, consensus has moved closer to what my expectation was. But what I find really interesting right now is that only four analysts see the 10-year Treasury ending above 2% at the end of the year. And in my opinion, I think this is a very complacent view, just like it was a complacent view in the first quarter.

My personal expectation for the 10-year Treasury is I think it’s going to rise to 2.25% as we get through the summer and you see this explosion of economic activity. But ultimately, I think it settles in closer to 2% at year-end. And the reason why I think that this is the case is that, if you look at the yield curve measured by the two- and 10-year [Treasury] in the US, it usually steepens out a lot further during economic expansions. And we’ve retraced about 65% of the levels that were seen during the last three recoveries, which does suggest higher yields from here.

But the key here is that I think the pace is going to be much more measured rather than the one-way street that we saw in the first quarter, because 10-year Treasuries look really attractive right now to European and Japanese investors on a currency-hedge basis. Most international investors, they really don’t want to deal with the moves of the dollar. So, they prefer to hedge out that currency exposure, and when you’ve seen the amount of yield pickup that you’re currently getting, it’s attracted a lot of overseas demand, which should put a buffer on how quickly rates can rise over the next couple of quarters.

But the one thing I want to mention here is that I think it’s important to remember that during the first two years of an economic expansion, it’s really common to see interest rates rise in anticipation of higher growth and inflation. And this makes sense because the economy is shifting to a new equilibrium for prices and interest rates. Taking a loan, this really doesn’t represent financial tightening and thus, the need for a negative market reaction.

For example, any impact that higher interest rates have on housing or autos, that really needs to be taken in context for the potential job growth that’s created, wage growth, demographics, and the increase of home prices. I mean, interest rates are really just one piece of the puzzle, and this can be overwhelmed by those other factors, which is why equities generally have a positive return profile during rising interest-rate environments.

In fact, since 1962, if you look at all the times where the 10-year Treasury has risen 1.5% or more, the S&P 500 [Index] has seen an average return of 11.9% during that rise. And if you look at the Russell 2000 [Index], since 1983, it did even better at 16.7%. So, rising rates don’t necessarily mean bad market performance. In fact, it actually means the opposite.

Host: Okay. Rates are a big piece of the puzzle. Another big piece of the puzzle on a lot of people’s minds is inflation. So many different opinions out there. Where do you see inflation heading?

Jeff Schulze: I think we’re going to have a temporary inflation scare as we lap the year-over-year inflation prints that we saw as the economy shut down. You also have the services sector that’s going to see price pressures, because there’s going to be a tsunami of demand. But unfortunately, there’s just not the supply there because a lot of services sectors have cut to the bone in order to survive in this type of environment, and you also have global supply chain bottlenecks. But this inflation scare is really going to be a US phenomenon because of the amount of fiscal stimulus that you’ve seen in the US, but also the progress that we’ve had on the vaccination front, along with the breakneck speed of the economic recovery.

The reason why I think it’s just a scare rather than something more longer-lasting is because there’s a lot of slack left in the labor market in the US. In both high-inflationary environments and low-inflationary environments, you really don’t see inflation start to take off until year four of that expansion, and the key is because you just have a lot of labor slack, and you don’t have the ability for wage growth to move materially higher.

So, there does appear to be a genuine concern that we’re on the path of a repeat of the 1970s, which was characterized by easy monetary and fiscal policy, but I think the big difference is that policymakers accepted the inflationary rise, which unanchored inflation expectations and created a self-perpetuating feedback loop of higher inflation.

I know we have a lot of monetary and fiscal stimulus today, but today, inflation expectations are firmly anchored. People are used to seeing prices low over the past couple of decades, central bank independence isn’t really being questioned at this point, and also today, you have a much better ability to monitor long-term inflation expectations. You have inflation-linked bonds, inflation surveys, forecaster inflation surveys as well.

So, the shift in inflation expectations isn’t going to take the Fed [US Federal Reserve} by surprise, which it did back in the 1960s and 1970s. And if you genuinely did see inflation expectations moving rapidly higher, I think that the Fed would respond pretty aggressively. And let’s not forget the Fed can always fight inflation because there’s no limit on how high the fed funds rate can go.

There’s also a couple of differences from today versus the 1970s as well. You have a labor market that is much less unionized and is much more flexible than the 1970s. So, having a wage-price spiral is much more difficult. You also have the Amazon effect. Consumers and businesses have never had an easier time being able to comparison shop. So, it’s much more difficult to see price increases. And you also have the ability for labor substitution. If wage growth really got out of control, companies have the ability to replace labor with robotics and machinery.

So overall, I think that we’re going to see a temporary inflation scare. I do think it’s just transitory. I do think, as we move into next year, inflation is going to come down because you have a lot of labor slack in the US economy, and more importantly, in the global economy as well, but regardless, reflation needs to happen before inflation and reflation has historically been really good for risk assets.

Host: Alright. We’ve touched on inflation and interest rates. You mentioned the vaccine rolling out, and that rollout ramping up. So bottom line, as we head into the summer, you see the economy picking up even more?

Jeff Schulze: I do. I think it’s important just not to get too bearish at this point in the cycle. Yes, the easy money has been made with “year one” officially in the books as of last month. Year one is characterized as a market that goes straight up and has minimal turbulence, but year two is a great year for investment, although it tends to be a little bit choppier.

If you look at every year two following a bear market low since 1966, the average return has been 12.4%, but in every single instance, you’ve had a positive return. And the one thing I want to stress here is that the Fed has had a regime shift. The Fed is no longer preemptively raising rates to get ahead of inflation. The Fed has clearly signaled that they want to see the whites of the eyes of inflation before they start to raise [interest] rates, and this is a really important development because the Fed has their fingerprints on almost every single recession, because they’re trying to fight inflation.

You put this a different way, instead of removing the punch bowl at 9 pm, like they traditionally have during economic cycles, the punch bowl is going to be out there well past midnight. So that’s going to be good for an economy that runs hot, but also good for financial markets overall.

Host: Great insights, Jeff. That’s Jeff Schulze, Investment Strategist with ClearBridge Investments and also the author of Anatomy of a Recession. You can get more of Jeff’s thoughts and check out the full Anatomy of a Recession program at

And if you’d like to hear more Talking Markets with Franklin Templeton, visit our archive of previous episodes and subscribe on iTunes, Google Play, Spotify, or just about any other major podcast provider. And we hope you’ll join us next time, when we uncover more insights from our on the ground investment professionals.

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