Data, data, everywhere: Three-minute macro

Data is our word of the month. Despite some surprising signs of economic resilience in the United States, our leading indicators still have us convinced a recession is on the way. Meanwhile, we don’t think the strong unemployment rate is a perfectly accurate description of the current (and future) labor market. Finally, the S&P 500 Index is looking strong so far this year, but we dive into how much of that performance is due to the AI craze.

The recession call stands

The “soft landing” narrative is gaining steam as some U.S. housing data has surprised to the upside and the much-predicted recession has yet to materialize after months of many highlighting the risk. While it’s certainly more fashionable to throw out one’s recession call, we don’t feel comfortable ignoring the significant downside risks to the U.S. economy. Our forecast still calls for a U.S. recession to begin in the second half of 2023 and we have high conviction in that outlook.

That conviction comes directly from the data: Our set of leading indicators continues to flash deeply red. Certainly, the exact timing of the recession (does it begin in Q3? Q4? Maybe even Q1 2024) requires some subjective interpretation. And this recession may have some characteristics that are different than those from the past—persistent labor shortages may mean the unemployment rate rises by less than in the past. But our forecasts are driven by data and models, and despite the recent headlines, the data continues to tell us one, clear thing: The risk of a recession is elevated.  

Lots of red signals

U.S. economic indicators

Table showing leading, coincident, and lagging economic indicators. Most of the leading indicators are flashing red, a sign of negative times to come.

Source: Manulife Investment Management, as of June 28, 2023. Red represents a clearly negative signal, yellow a deteriorating signal, and green a still strong signal. C&I refers to commercial and industrial. ISM refers to Institute for Supply Management.

How tight is labor really?

We’re big believers in the structural changes affecting the global economy on both the growth and inflation side. For example, we continue to believe that the drivers of inflation are shifting and are becoming more supply side and globally driven in a way that will likely keep prices elevated compared to the post-global financial crisis period. We’ve also been vocal that the significant shortage of labor in the United States is an important change relative to pre-COVID-19. The unemployment rate at 3.5% is the lowest it’s been since the early 1970s—how can the U.S. economy be at risk if effectively anyone who wants a job has one? In our view, it’s going to become increasingly important to look at alternative gauges of labor market weakness. If companies are scarred from the difficulty in getting workers on payroll, we expect a greater reluctance to cut jobs completely.

How might companies scale back in the face of economic weakness then? One way may be to keep workers employed but cut their working hours. Indeed, the total hours worked in the economy is now back to pre-COVID-19 levels, implying that even if the number of jobs is quite high, the availability of “work”  is declining. As we move forward into the next recession, we expect many Americans to stay formally on “payroll” but we won’t be using that single data point as the best indicator of economic strength anymore. 

The U.S. labor market is showing cracks

Hours worked and initial jobless claims, United States

Line chart of average weekly hours worked and initial jobless claims in the U.S. The former has decreased and the latter increased since 2022.
Source: Manulife Investment Management, as of June 29, 2023. YoY refers to year-over-year. Grey areas represent U.S. recessions. 

How is AI affecting the way we’re looking at the macro picture

Though U.S. stocks have already clawed back much of their 2022 losses, it’s worth noting that this has little to do with optimism about growth—indeed, from an investor perspective, there’s little to love about stagflation and a hawkish U.S. Federal Reserve (Fed).  In our eyes, what looks like a rosy equity market is mostly just mega-cap tech stocks surging off the excitement around AI.

Here’s why that matters:

  • Stocks aren’t “ignoring recession risk”: The S&P 500 Index excluding the top 10 AI stocks is up a mere 1.2% year to date even as the broad S&P is up over 14.0%. Or take a look at the small-cap S&P 600, which is down ~15.0% since January 2022 and ~7.0% since February’s most recent high. That’s not broad euphoria about growth prospects at all. The AI surge is also a market concentration problem: If we get a pause in these big tech names as the AI story becomes more fully incorporated, what’s the next driver of stocks in an environment of low growth and high inflation? We’re struggling to see it and we’re not sure how many more months of cover we can get from the tech story.
  • Secular trends move markets: This is a point we’re happy to make again and again as we take a deeper dive into more thematic concepts this year. In this case, a big picture, emerging long-term theme is upstaging more historical approaches to market views.
  • Beware of bubbles: Some data suggests AI stocks are resilient given their transformative potential (and reliance on software, which may help them withstand market volatility). For example, Nvidia is up 180% this year, but its earnings expectations have also almost doubled, “justifying” the price somewhat. For others, the mania feels a bit too much like tulip bulbs, dot-com, crypto overexuberance. Let’s just say this: The Fed—which we know loathes “excesses” and, in our view, would probably prefer to see asset prices declining—isn’t likely to be comfortable with the recent markets or its drivers. Anyone assessing the odds of another rate hike from the Fed will have to acknowledge that the recent AI stock rally is likely to encourage another vote in the “one more hike” column.
  • AI might help the existing labor shortage more than create one: A few years ago, we’d get asked whether AI would replace jobs. Now we have 0.6 people available for every job opening and what’s looking like one of the most pronounced labor shortages of the past several decades. So as we assess the implications of AI on long-term growth forecasts, we’re more likely to view AI as a productivity accelerant in addition to a solution to the drag on growth caused by the lack of working-age individuals in developed economies rather than an economic problem that diminishes outcomes.
AI is driving S&P 500 performance

Normalized performance, year-to-date (%)

Bar chart of the performance of the S&P 500, broken down by the top-10 AI stocks versus the rest of the S&P 500. It shows AI stocks accounting for more and more of the broad gains in the S&P 500 over the first half of 2023.
Source: Manulife Investment Management, as of June 29, 2023. The top 10 AI stocks in the S&P 500 are selected from the 10 largest companies (by market cap) in the Indxx Artificial Intelligence & Big Data Index. 

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Frances Donald

Frances Donald, 

Global Chief Economist and Strategist

Manulife Investment Management

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