30 May 2025
CONTRIBUTORS | Jeffrey Schulze, CFA, Head of Economic and Market Strategy
Podcast transcript
Host: Welcome to Talking Markets with Franklin Templeton. We're here today with ClearBridge Investments Head of Economic and Market Strategy Jeff Schulze. ClearBridge is a specialist investment manager of Franklin Templeton, and Jeff is the architect of the Anatomy of a Recession program, a program designed to provide you with thoughtful perspective on the state of the US economy.
Host: Jeff, with recession fears growing, I wanted to start off by checking in on the health of the US economy. Did the ClearBridge Recession Risk Dashboard have any changes at the conclusion of April?
Jeff Schulze: Really excited to be here. Thanks for having me. And, while it's too soon for the hard data indicators to show trade-related weakness, profit margins was seeing headwinds even before “Liberation Day” tariff announcements happened earlier last month. It worsened to a cautionary yellow from a green expansion, but the overall dashboard still remains in expansionary green territory, and there weren't any other indicator changes that month.
Host: So, profit margins changed to yellow. Does that concern you a bit more than usual?
Jeff Schulze: The deterioration in profit margins reflects events that unfolded prior to the escalation of the trade war. So inflation, essentially pricing power of corporations, it's cooled a lot more rapidly than wages and other key inputs, from a cost perspective. And that's ultimately crimped profits. And that's driven profit margins down from record levels, which is the reason for the signal change. Now, in the absence of a trade war, this dynamic would be much less concerning to me.
But today you have the prospect of additional strain on margins in the coming months as higher tariffs are going to come into the cost structure. So the reason why this is worrying is that as margins contract and profits erode, corporate management teams often are forced to lay off workers and that starts or even amplifies a recessionary feedback loop as consumers pull back, given their loss of income.
So yeah, I'm a little bit more concerned than usual just because we have this force that's likely going to weigh on profit margins further as we look ahead in the coming months.
Host: Okay. Let's talk about the labor market given weaker profit margins. The April jobs report was out last week. It looked to me like a solid report. And markets seemed to respond in a positive way. What's your view?
Jeff Schulze: It was a rock solid jobs report. That's exactly what you want to see. Nonfarm payrolls for April was 177,000. Yes, you had some revisions downward for the prior two months, but the three-month average job creation right now is still at a very healthy 155,000.
Unemployment rate didn't change. You even saw a little bit of a tick up of the labor force participation rate. It was a good print, and you really can't poke a lot of holes in it. And I think the key takeaway here for the listeners is that the April jobs report shows that the labor market was on a solid foundation as the trade war tensions became much more disruptive early last month.
And the data for this release was actually collected the week following the Liberation Day tariff announcements. So it can't be completely dismissed, because it does reflect some elevated uncertainty because of the increase of tariffs. But I think also more importantly, it's a little bit too soon to expect the substantial fallout to emerge quite yet. So this may be the calm before the storm.
We're going to be looking at the jobs report very closely in the coming months, to see if it does kick down into a lower tier. But the good news is that the labor market was pretty solid as we were going into this period of uncertainty. So that's a really positive dynamic, and it's a key reason why our base case right now continues to be that we are not going to have a recession.
We think GDP growth is going to be around a half a percent this year. And the labor market strength that we're seeing is a key reason for that.
Host: Are there any other important labor market data points that you're watching?
Jeff Schulze: Initial jobless claims are maybe the single most important economic indicator to watch. If I was on a desert island, and I only had one piece of data to monitor for the economy, it would be initial jobless claims. Top-three indicator in the Recession Risk Dashboard. We like to refer to it as our canary in the coal mine. And claims have been holding up extremely well in the weeks following the Liberation Day tariff announcements. And although the latest release saw a jump of claims by 18,000 up to 241,000, when you look beneath the surface, that jump was from New York, where some school workers were allowed to claim jobless benefits during the spring break.
And you see this every year and we're likely going to see claims jump back lower as we get this week's release. So the four-week moving average is about 266,000—very healthy number. It's been around these levels for the last couple of months. If we start to see this increase, we're going to get a little bit more concerned. But at this point it looks like employers are not letting go of their workforce because of the uncertainty that we have with tariffs.
Host: Okay, Jeff, another important indicator on the ClearBridge Recession Risk Dashboard is credit spreads. You mentioned on last month's podcast that we could see that indicator change this month. Any update on credit spreads?
Jeff Schulze: Well, this is again another top-three indicator. So this is one that you want to have as green along with initial claims. And when we had done the podcast credit spreads were blowing out. And we look at high yield spreads in particular. And credit spreads had gone from around 315 basis points in late March to about 450 basis points on April 7th. So that's a pretty big move in a short period of time. But since we've gotten some positive developments on the trade front, and we've gotten some more resilient economic activity that has dropped down and done a round trip back to 350 basis points.
So it's a little higher than where we were in late March. But for some perspective, if you look at recessionary periods, high-yield spreads usually gets about 800 or 900 basis points. And at 350 we're well beneath those levels. So it appears that fixed income investors aren't really concerned about a recession materializing in the US economy.
Host: Okay. GDP in the US was negative in Q1. Does that mean we're actually already in a recession?
Jeff Schulze: It doesn't. I know a lot of people think that it's two negative quarters of GDP is a recession, but there's a lot more that goes into that calculation by the NBER [National Bureau of Economic Research]. But when you look at the data specifically, it was distorted because of a couple of factors.
First off, you had the largest ever drag on growth from net exports as people were front- loading things before those tariffs. Net exports actually shaved 4.8% off of this quarter’s GDP reading. When you have a lot more imports than exports, that's actually a negative to the GDP calculation. So that was one important driver of that negative number. You also had some weather-related distortions to consumption—coldest January that you had since 1988 in the US. You had the worst flu season since 2010. That weighed on consumption. And as the weather warms up, consumption should be more robust. And then also you had a normalization of aircraft production and defense spending this quarter compared to quarters prior. So when you put this all together, the GDP print is being pushed down artificially.
A way to kind of get a good gauge of the real trajectory of the economy is to look at real final sales to private domestic purchasers. I know that's a mouthful, but it's a similar concept to core CPI. This is a core GDP concept. It excludes things like trade. So those imports/exports that we talked about are not in the calculation. It takes out inventories, and it also takes out government spending. And this core GDP reading came in at 3%, which is right in line with what we've seen over the last couple of years.
So coming back to what we said about the labor market, labor market’s on a good foundation coming into this period of uncertainty. So was GDP when you look at it from a core measure, also.
Host: The title of this month's Anatomy of a Recession commentary is “Vibecession or Recession?” What does that mean?
Jeff Schulze: Well, whether the hard data (so, the actual economic releases that you see) will ultimately follow the soft survey data that individuals answer (how do they feel from a consumer or a business perspective?).
And this primarily stems from what occurred in 2022, when the soft data weakened in the wake of the Russian invasion of the Ukraine, the regional bank crisis, elevated inflation—but the hard data largely held up. So this period came to be known as the vibecession because even though many Americans didn't feel great about the health of the economy, they continued to spend in a very healthy manner because of the strong labor market, prior fiscal support. So the stimmy checks and then residual pandemic savings.
So, you think about where we are today. You know, maybe it's a little bit of a different situation than where we were back in 2022. But we just won't know until we look back and we can see what the hard data actually does. Now, if you look at the survey data, you've seen a big deterioration in the first quarter, and that accelerated in April.
And there's really two main consumer sentiment surveys, the University of Michigan survey and the Conference Board's Consumer Confidence survey. When you look at the Conference Board survey, it had dropped 18.9 points from the November highs through March. And then in April, you saw another 7.9-point decline. So we're basically back at the 2020 pandemic lows. And when you see deteriorations like this, they only occur during recessions.
So the degree to which this softer survey data will translate to actual hard data is going to be really critical for the economy going forward. And there are some signs that there is some cooling out there. Labor income obviously is the most important dynamic for the consumption backdrop because people spend what they make, and there are some anecdotes of consumers retrenching.
Chipotle CEO Scott Boatwright said on the first earnings call that saving money because of concerns around the economy was the overwhelming reason consumers were reducing the frequency of restaurant visits. So there's more to this story to be told. Will the soft data lead to weaker hard data? We're not sure. It didn't materialize in 2022, but I think it, as we talked about earlier, it comes back to the labor market.
If the labor market can hold in there, we think that a recession can be avoided and a soft landing will be the outcome.
Host: In the past, large drops in consumer confidence have led to a recession. What has that meant for US equities?
Jeff Schulze: Well, believe it or not, it's really good for US equities. Not the recession itself, but when confidence bottoms out.
So, we talked about the Conference Board's consumer confidence survey in the previous question. I want to talk a little bit about the University of Michigan's consumer sentiment survey. Now for the final release for April. This came in at 52.2, which is near an all-time low. And this is a survey that goes back to the early 1970s. So we have over 50 years’ worth of data. But when you look at the 11 major low points of consumer sentiment with this survey going back to the early 1970s, if you had bought the S&P 500 at the lows of sentiment, your forward 12-month return on average has been 25%. So, just like when everybody's bearish, it's a good time to be bullish, when you think about investor sentiment, the same thing can be said with consumer confidence. And if this is a trough level of consumer confidence, history would suggest that you're going to have more positive market returns as we look towards the end part of this year.
Host: April 2025 was quite a volatile month for the S&P 500 Index as it almost hit bear market territory. But Jeff, even though we've seen a recovery, do you have any historical insight to help us think about an equity market drawdown of this magnitude?
Jeff Schulze: Well, it's often said that March comes in like a lion and out like a lamb. The reference goes to the transition from winter to spring weather, but it may be more applicable to what markets experienced in April. The S&P 500 fell in the week following the president's Liberation Day tariff announcements by 11%, and equities were at the precipice of a bear market. The drawdown was -19% from the February 19th peak, but stocks rallied in the back half of the month when we started to get signs of tariff de-escalation. And believe it or not, the S&P 500 was down just 0.8% for the month of April.
So I think it's really important that you be flexible on what can happen as things are occurring over the course of the next couple of quarters. And, you know, this is a manmade disaster and all it takes is a positive tariff announcement or a change in policy to really change the perception of where the economy and earnings are going to go for the S&P 500.
But you mentioned historical context. One thing that we've been advocating to our clients is the fact that we hit a correction in the S&P 500 is usually a good time to put money to work. And a correction is a 10% drawdown. We've had 34 of them since 1950 and we've had no recession. Six and 12 months later, you bought the day that you hit correction territory, you had a positive 9.2% and 13.9% return, respectively. But what may be more surprising to a lot of listeners is that if you had a recession, your forward six- and 12-month returns were actually still positive. They were lower at 2.8% on the six-month time frame and 1.2% on a 12-month time frame, but they were still positive.
And a lot of people think that when you have a recession, it needs to be a big drawdown, like in ‘08, where it was a 57% drawdown for the S&P 500, or ‘01, 49% drawdown. But a lot of recessions really are much more muted from a market perspective. In 1980, you only had a 17% drawdown for the S&P 500. 1990, that number was 20%. 1982 it was 27%.
And the fact that we already saw a 19% drawdown in the S&P 500 means that we've already reached the levels that were seen in the 1980 and 1990 drawdowns. So things are going to be choppy as we look forward. There’s going to be some twists and turns. You're going to start to see the economy slow. You may have a little bit of an air pocket because of the pull forward because of tariffs.
And we would just say that regardless of economic outcome, the economy is on a pretty solid foundation right now and there's not a lot of structural excesses. The consumer's in good shape. Bank balance sheets are in good shape. There's no real obvious bubble that's out there. And if we do have a recession, it's going to be pretty mild.
And the associated sell off, in our view, would be similar to what you saw in 1980, 1990 or 1982. So we're just advocating as we move through the period of choppiness that you dollar cost average into this, regardless of what ends up happening with the economy.
Host: Okay. So given that insight and given what you just said about dollar cost averaging into opportunity, where do you see opportunity in US equities on a go forward basis?
Jeff Schulze: We think active managers in the large-cap space have a pretty good advantage versus passive indices. Active managers in the large cap core, 58% of them are beating the S&P 500 year to date. This is the second highest reading since the COVID-19 pandemic and ranks third overall going back to 2007. So this is really a dynamic where the Magnificent Seven,1 when it lags the market, is a nice tailwind to active outperformance.
And, right now, the top 10 names in the S&P 500, they make up about 35% of the index. And when the top 10 names make up 24% or greater—so well below that threshold where we're currently at—your average returns of the equally weighted S&P 500 or the average stock compared to the cap-weighted index (so, what does the average stock do versus the index?), the average stock has outperformed by 6% per year over the next five years on average. So active managers that can sidestep some of that market concentration have a competitive advantage versus passive indices that can't.
And a great analogy is to look at the last time you had a lot of market concentration, which was March of 2000, and you look at the top 10 names at that point. Fast forward to today (so 25 years later), only Microsoft and Walmart are outperforming the S&P 500. All the other eight underperformed. The S&P 505 of the names actually have negative returns, absolute returns over the last 25 years. So now we see this dynamic playing out over a multi-year time horizon. And we think active managers really have a competitive advantage in this environment.
And by no means do I think that this is the bursting of the “dotcom” bubble. But I think that's a good reference for the last time that we saw elevated market concentration. And then the other area that I think there is an opportunity is for dividend growers. These are companies that have proven track records, high degree of earnings visibility.
These companies have strong balance sheets, moats around their businesses. They do really well when markets are choppy. And they also have a fundamental reason that they can outperform going forward as well. Recently, dividend growers closed one of the largest 12-month performance gaps in the last 30 years relative to the S&P 500. And when you've had following similar periods of underperformance like the late 1990s and the early 2020s, dividend growers went on to outperform the S&P 500 in the subsequent years.
So I think that this is a really good asset class to look at if you want to have exposure to the equity markets but want to have some downside protection, if you see some choppiness and potentially a shallow recession emerge.
Host: Okay, that's great. So active management with large cap core and dividend growers. Jeff, at this point we're moving to the close of our conversation this afternoon. Do you have any closing thoughts for our listeners?
Jeff Schulze: A lot of things are fluid right now. Right now, given where the market has moved following the lows in April when we had that round trip, the risk-reward facing the economy and the markets is skewed slightly to the downside at the moment.
But all it takes is a positive change in trade policy or a renewed focus from the administration on its supply side agenda like deregulation, tax cuts and fiscal support, which can really start to shift that skew in a more favorable dynamic. And we've obviously seen that happen here recently. But the key takeaway here is that prompt action is needed to counteract the negative and building effects of elevated uncertainty and those margin pressures that we talked about earlier.
But there is a lot of movement in the trade area. It appears that China and the US are going to be starting some tariff talks in the next couple of weeks to months. You could get some memorandums of understanding, better known as MOUs, with trading partners. That creates space for extended pauses on those reciprocal tariffs. And you could start to see some of these sectorial tariffs have some carve-outs. And you saw this with auto parts last week. So if tariff rates are coming down, if we start to get some tariff deals and trade deals into place, a lot more certainty comes into the equation. And with fiscal stimulus likely coming in the back half of the year, we could see some choppiness. But ultimately we think that the market will move higher.
So the key is that the economy was on a solid foundation coming into this tariff uncertainty. The quicker that this uncertainty is lifted, I think the higher that the markets can go. But I think it's going to take a couple of months to be able to work through this. And ultimately we think, should you see higher volatility and potential downward pressure in the markets, to dollar cost average into that, even in a shallow recessionary environment.
Host: Jeff, thank you for your time and your terrific insight this afternoon.
To all of our listeners. Thank you for spending your valuable time with us for today's update. If you'd like to hear more Talking Markets with Franklin Templeton, please visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify, or any other major podcast provider.
Endnotes
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