The economy is more than likely headed for a slowdown in the coming months, and some markets are better prepared than others for it, said three chief investment officers at a webinar hosted by Franklin Templeton today.
During the webinar, entitled “The Corporate Conundrum: Impact of Rising Costs on Business Profits,” the three panelists agreed that an economic slowdown was possible in the coming months. They also agreed that the prognostications about a recession have changed dramatically over the past year.
“I think it’s interesting how that recession narrative has played out over the past year or so and how it sort of shifted and oscillated,” said Michael Buchanan, co-chief investment officer at Western Asset.
While they weren’t calling a definitive recession, the CIOs said the economy could experience a slowdown.
“We have been of the opinion that the recession preconditions are in place,” said Scott Glasser, chief investment officer at ClearBridge Investments. The “yield curve obviously reflects the strong potential ... for a recession [and] the leading economic indicators [are] pointing us in the direction of recession.”
Two other economic factors, he said, include current credit spreads, which are higher than they have been (though not quite at recessionary levels) and labor, which continues to be strong.
However, while there might be warning signs ahead, the panelists agreed that not every sector is preparing sufficiently for a slowdown. For instance, Glasser said he was not pleased with the reaction from the equities markets.
“I think the equity markets are a bit too complacent in terms of what earnings are going to look like and what potential economic weakness could be over the course of the next 12 months,” he said.
There is a lot of uncertainty when it comes to the equity markets, as there is still a question about interest rates and how long they will remain at their current levels. Recently, liquidity has become restrictive, Glasser said.
If rates stay where they are, it will continue to restrict liquidity, which will eventually put a pinch on the economy, he said.
The markets are making efforts to correct those situations, though those efforts have not been sufficient or are not fully realized, Glasser added.
“I think the correction is ongoing, and it’s not over yet,” he said. “I have not been impressed with the rebound that we have had.”
The fixed-income market is a different story, according to Buchanan, who said that past experiences may affect future behavior. He highlighted the impact that the 2006 global financial crisis had on company executives and the scars it left on them.
The result is they are much more proactive when it comes to refinancing and not waiting for bonds to come due so they won’t be at the mercy of Wall Street, Buchanan said. In addition, firms are operating with a more positive balance sheet and more conservative bias in their finances.
“If we do in fact slip into a recession over the next two or three quarters, I think there is going to be something unique and different about this market,” he said. “I think that balance sheets are in a reasonably decent spot to withstand a recession.”
One bright spot is that firms are conducting business in a way that should stave off many of the defaults expected during such a downturn.
“This relates to that conservative oversight that we’re seeing and what we think are healthier balance sheets than we might typically see going into a recession,” Buchanan said. “I do think that will result in a lower default experience.”
The panel also talked about the global political climate, specifically the war between Israel and Hamas, and its economic ramifications. Cash is one asset class that could benefit from the turmoil, said Ed Perks, chief investment officer at Franklin Income Investors. While he would not call it a major asset class everyone should think about, its function within a portfolio could improve amid the current instability, he said.
“In prior cycles in our recent past it was pretty difficult to hold cash balances, [because] it was a real drain on potential returns, so you really had to be banking on a negative dynamic in price and markets to justify it,” he said. “I think that’s a bit of a different situation today. ... To the extent you want to offset geopolitical risk and greater uncertainty, I think it does push you to consider more cash in a portfolio.”