Beyond Bulls & Bears


PODCAST Anatomy of a Recession update: US labor market cracks emerging?

In this conversation with Jeff Schulze, head of economic and market research at ClearBridge Investments, we focus on the US employment market and consumption, receive an update on the ClearBridge Recession Risk Dashboard, and discuss the on-again, off-again, soft-landing narrative.

Listen to our latest “Talking Markets” podcast.


Host: Welcome to Talking Markets with Franklin Templeton. Today we’re talking about the state of the US economy with Jeff Schulze, Head of Economic and Market Research at ClearBridge Investments, a specialist investment manager of Franklin Templeton. In our last conversation with Jeff, we discussed a wide variety of economic topics, including the US debt ceiling being breached and the potential catastrophic events of a US government default. The crisis has been averted as Congress has passed a bill raising the ceiling that’s been signed by President Biden. Today, we’re going to focus on the US employment market and consumption, as well as ask Jeff for an update on the ClearBridge Recession Risk Dashboard and discuss topics like the on-again, off-again, soft-landing narrative. Welcome, Jeff, and thank you for joining us.

Jeff Schulze: Excited to be here.

Host: So, Jeff, let’s start by touching on the strong US equity performance of late. What’s your take on this run?

Jeff Schulze: Well, it’s a run that’s surprised a lot of investors, quite frankly. But more recently, you’ve seen a rally, and that’s not uncommon. As the Fed [US Federal Reserve] does its last rate hike and between the first rate cuts, there’s usually a market that cheers that dynamic, because the Fed is done with their tightening cycle yet there’s not a clear indication of a recession.

And I think that’s one of the reasons that you’ve seen the market rally. And that rally can continue for the next month or so. But if you look at what’s been rallying, there’s a very different experience between what we’ve seen in the overall S&P 500 Index, which is market cap-weighted, and the equally weighted version of that same index. The difference in performance is the starkest that you’ve seen since the late 1990s. Looking at it from a different vantage point, the five largest members of the S&P 500 have delivered 85% of the index’s total return this year, which means the remaining 495 companies have contributed just 15%.1 So, typically, when you have deteriorating or narrow market breadth, it’s associated with a bull market that’s on its last legs and not a solid foundation for a rally to continue to build upon.

Last thing I’ll mention on it, as of the end of May, a little bit over 40% of the S&P 500 was trading above its 200-day moving average,2 which is remarkably light if the October lows that we saw in 2022 was the start of a new bull market. So, a lot of the strength that you’ve seen has been in your mega-cap tech companies in areas that are going to benefit from this AI movement.

Host: So, it sounds like we could be at the end of a bull. How does employment factor in here? Recently, we received some data that appeared to be pretty outstanding. The labor market seems to be holding steady. What are your thoughts on those reports?

Jeff Schulze: Well, obviously this is one of the reasons that equities have been moving higher. But, similar to equities, the US labor market is also seeing deterioration if you look underneath the surface—although the headline figures remain pretty resilient. So, we just got a job openings number for April. We saw a jump up to 10.1 million job openings, which is three million more than what you saw prior to the pandemic. This has been an area that’s been dropping pretty dramatically. But this is a change which shows that there still indeed is robust demand for labor out there. Looking at it from a different vantage point, the number of job openings per unemployed people, the ratio jumped back up to 1.8. This is well ahead of the highs that you saw prior to the pandemic of 1.15. So, you still need to see a weakening of labor demand with job openings. The May [US] payroll release was also way ahead of consensus expectations at 339,000 jobs created over the course of this year. You’ve seen an average job creation of about 314,000 per month. And to put that number in perspective, the last time you had sub-4% unemployment, which was back in late 2018 and 2019, the average job creation was about 140,000 per month. So today you have about two times what you could expect to be normal in this type of environment.

Also, you’ve seen 14 consecutive monthly non-farm payroll beats versus consensus expectations, which is the longest run of beats that you’ve seen in 25 years. So, the labor market continues to be red hot, but it’s not all roses and sunshine. You do have some deterioration and some data that suggests that things may be turning.

Now, usually when you get the jobs report, you have the establishment survey where you get the jobs number from. And this is gotten from calling businesses on employment. But there’s a second survey, which is the Household Survey, where households are called about their employment prospects. And this is where we get the unemployment rate. Now, you saw a very soft number from the household survey coming in at -310,000 jobs. And this caused the unemployment rate to jump from 3.4% up to 3.7%. Now, divergences between these two surveys are not uncommon when you have an inflection point in the economy. And usually the household survey historically has been more correct of the two. So, this is something to watch as we go forward. But if this is actually accurate, you’ve seen a 0.3% increase of the unemployment rate off of cycle lows.

And historically, you don’t get just a little bit of job loss. Usually when you see it spiked at these levels, unemployment rises to 1.5% to 3% in total. So, this implies that there’s a high degree of uncertainty given this divergence. And we’re going to be watching these releases very closely as we look out into the back half of the year.

Host: Thank you, Jeff. So, although the headlines appear to be very positive, as you’ve just taken us under the ‘hood, there clearly are some substantial concerns that may begin to play out here as we move forward. Let’s transition a bit and connect directly to the consumer and consumption. You’ve previously highlighted a concern about tightening lending standards. Is that starting to become a reality?

Jeff Schulze: Well, yes, it is. One of the other areas of weakness in the labor data was initial jobless claims. Now, this is one of the top three variables that we have in the dashboard. It’s currently a cautionary yellow signal. So you have seen a shift higher in this number over the course of this year.

But if you dig underneath, there’s an increasing number of people who are from the middle- and upper-income cohorts who are filing for unemployment claims. And if you look at the lower-income cohorts, you’ve actually seen this decline. This is not the dynamic that you typically see historically, but it’s not out of sync with what you’ve seen with the headline job loss that you’ve heard in the news cycle, which has been concentrated in higher-paying areas like technology and financial. So given this unique shift towards higher earners losing their jobs, consumption may have a bigger drop than expected with this level of jobless claims that we see again as we move into the back half of the year.

Now, that’s not the only thing that’s going to weigh on consumption, right? You mentioned tightening lending standards. If you look at willingness to lend to consumers, it’s at -22. That is a level that’s historically consistent with a recession. And maybe more importantly, the most recent release that we got in revolving credit saw the biggest jump in credit card debt in over a year. And that’s pretty concerning with the average interest rate on credit card debt above 20%. And from my vantage point, it really suggests that consumers are using credit cards more out of necessity at this point of the cycle.

Also, with the rising of the debt ceiling, the student-loan moratorium is going to be coming to an end. And this is going to affect roughly 45 million Americans that are going to have to start repaying their student loans in September. And a study done by the New York Fed suggests that the average loan payment is about $393 per month.

Now, if people weren’t paying their loans for three or six months, this wouldn’t come as a genuine shock. But people haven’t been paying their loans for over three years. So, there’s a lot of reasons why we think consumption, although it’s resilient at this point, may take a step down as we move into the third quarter.

Host: So last month, the ClearBridge Recession Risk Dashboard had three indicators moving in the wrong direction. Where do we stand with the May 31 update?

Jeff Schulze: So, we continue to have the same dashboard as of the end of April—10 red, two yellow, zero green signals—but still a very strong overall recessionary red signal coming from the dashboard. Now, last month we talked a little bit about job sentiment and it moving to a red signal. We saw continued deterioration in this labor indicator. As a reminder, we get this from the Conference Board’s Consumer Confidence Survey, and we’re really looking for the number of respondents that say jobs are plentiful minus those that say that jobs are hard to get. And in the latest release, the share of workers saying that jobs were plentiful had fallen and those reporting that jobs were hard to get had modestly risen. So this is an indicator that dropped almost six points to 31, which is the lowest level since April of 2021. So, similar to what we’ve talked about in a lot of these questions, another leading labor indicator that suggests that things are going to slow as we move into the back half of the year.

Host: Okay. So, it’s interesting, as you mentioned, that things are going to slow. My next topic I wanted to bring up here is the concept of a soft landing. It seems to be a conversation point once again that’s been popping up. Is it realistic or is it simply just an attention-grabbing headline?

Jeff Schulze: Well, it’s realistic. We continue to believe that there’s a 75% probability of a recession. So, there’s a 25% probability of a soft landing. And that could take a number of different paths to it. There’s this idea of the immaculate slackening, the idea that job openings are three million above what we saw prior to the pandemic, which was 7.1 million. If we can get this into the eight or seven million range, that could cool wage growth and cause the Fed not to tighten even further than they have. The one thing I’d mention: this has never happened before. Usually when you see a big drop of job openings, you see a large layoff cycle. But there’s been a lot of firsts this cycle, and this may be another that you put on the mantel when we look back in the history books.

The second path to a soft landing is this idea about a sectorial rolling recession, meaning that you’re going to see different areas of the economy go into a recession. And by the time they come out of recessionary territory, other areas will be seeing weakness—so they all don’t go down at the same time.

Now, thinking about this story, housing would be the first to go into a recession. It may be troughing as we currently speak. Also, if you look at tech, it’s kind of had a mini cycle that looks pretty advanced. Manufacturing’s likely going to be the next shoe to drop and it’s going to enter into a recession either this quarter or next. And then services will hold up until 2024 when households exhaust their excess savings and those tighter lending standards exert pressure on the labor market. So we may not have all areas fall into recessionary territory at the same time. Now, I’m going to be skeptical of this because almost every recession is a rolling recession, right? If you go back to the global financial crisis, you saw the housing collapse drive residential investment, a component of GDP [gross domestic product], negative year-over-year back ’06. And, it was two years before consumer spending and CapEx [capital expenditure] eventually turned down. And you can really say that same story about every recession except for COVID, which was an exogenous event. But that is a second path to a soft landing. But again, I don’t put a high probability of it on that.

And the last one is that maybe the consumer can stay more resilient than people anticipate. Maybe because of high compensation, resilient incomes, consumption can hold up here. There’s still about a trillion dollars of excess savings that’s out there. And even though we’ve seen excess savings dropping to a much more minimal degree recently, maybe that continues to come into the bloodstream of the US economy.

And the last thing I’ll mention is that usually, as you see the economy slow, you see an increase of precautionary savings and that may not materialize. If you look at the savings rate, it jumped from 2.7% up to 5.1% recently. But the most recent release had a drop back down to 4.1%. So given that households are in a really good position right now from a financial standpoint, maybe they will maintain a low savings rate. So again, we think there’s a very strong possibility of a recession, but there is still a path to a potential soft landing that’s out there.

Host: In our recent conversations, Jeff, you’ve made a very clear distinction between the lagging and leading economic indicators, really putting focus on the leading indicators as the elements that we should be following to see the path that is potentially before us. Have you seen any change in the leading indicators of late?

Jeff Schulze: We have, and they’ve gotten worse. The LEIs, Leading Economic Indicators, from the Conference Board have been declining for 13 consecutive months. The only two times where you saw a larger consecutive decline of months was in 1973 and in 2008. So, a pretty high bar here, clearly in recessionary territory. Looking at it from a different vantage point, the largest contraction of the LEIs on a year-over-year basis before recession materialized was -5.7% ahead of 1980’s downturn. We’re clearly through that at -8%. So, a lot of the data that we’ve seen that has been strong is lagging or coincident (tells us where we’ve been or where we are). When you’re driving, you want to be looking through the windshield and by looking at the LEIs, it’s suggesting that you’re going to have a slower economy and, in our opinion, likely a recession sometime over the next six to 12 months.

Host: Switching topics here to the Fed, the FOMC [Federal Open Market Committee} meets again next week and it seems like potentially a pause or maybe another 25-basis-point hike is on the table. My question for you, Jeff, is at this point, does it really matter?

Jeff Schulze: I don’t think it does. I don’t think it mattered that the Fed hiked in May. I don’t think it mattered, quite frankly, that the Fed hiked in March. I think that the die is cast. The economic cake is baked, if you will, for a US downturn. Now, will the Fed hike again? Well, I think in June that’s been really taken off the table.

Unless we see a huge beat on the CPI [Consumer Price Index] to the upside that we’re going to get in about a week, because there was a speech that was done by the Vice Chair Elect Jefferson, who sent a pretty clear signal that they want to see the lagged effects of Fed tightening and more data before making decisions on additional firming. It doesn’t mean that we’ve reached peak Fed funds rate, but they do want to see if the economy slows notably from here.

But if we do get a hot CPI print, I think that the odds of a June rate hike will rise given the very hot job opening number that we had and, again, the warm headline payroll release that we got last week.

Host: It’s hard to believe, but we are now in the final month of the second quarter of 2023 as we continue to drive forward here throughout the year. Is there any specific data or reports that you will be keeping your eye on as we move forward?

Jeff Schulze: There’s definitely a couple. I just mentioned before the divergence between the establishment and household survey with the jobs releases. You’ve also seen hours worked steadily fall since peaking in early 2021. Now, usually hours worked fall as the economy enters into a recession as employers cut shifts because of declining demand. But today, this has actually slipped below the average level of hours worked during a week that we saw last expansion. And there’s really no signs of stabilization there. So this is something to watch. And I think it’s interesting that you’ve seen a cut to hours worked, but this surge in hiring. And this is indicative in our opinion of labor hoarding because businesses are reluctant to let go of headcount after the hiring difficulties they’ve experienced in recent years. And while labor hoarding can certainly continue, we believe it’s only a matter of time before profitability pressures.

And we talked a little bit about this in April with small business seeing a host of profitability pressures, whether it’s hiring, borrowing costs, tighter lending standards, the inability to pass on higher prices to consumers or stickier cost structures before those profitability pressures lead to broader cutting measures, including a layoff cycle. So we’ve seen the layoffs really concentrated in large-cap companies, large tech in particular.

We think, because of these profitability pressures, you’re going to see a broadening of that layoff cycle to Main Street America, likely in the second half of this year. So, I think focusing on the labor market is area number one that we want to be looking at. But secondly, do we continue to see sticky inflation? And although headline inflation has moved down quite a bit, core inflation continues to be very sticky on a three-month annualized basis it’s at 5.1%, which is stubbornly high, and it’s going to keep the Fed’s foot firmly on the economic break.

Host: We’re going to end it there today. Thank you for your terrific insight as we navigate the markets. Once again, today’s guest was Jeff Schulze, the architect of the Anatomy of Recession program. You can prepare yourself by reviewing Jeff’s monthly commentaries and checking out the dashboard at

If you’d like to hear more Talking Markets with Franklin Templeton, visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify, or just about anywhere else you listen. Thank you for joining Talking Markets.


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