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A 2023 recession is more or less the consensus forecast for the US economy at this point. However, most market participants seem to believe the US can avoid the dreaded “hard landing” scenario as the labor market remains tight amid robust domestic consumption. We disagree and believe the US economy is likely to falter meaningfully in 2023, with the risk of many resulting job losses.
Remember, employment data is a lagging economic indicator, and our own review of high-frequency job openings data points to a likely deterioration in the US labor market that will potentially manifest within nonfarm payrolls and jobless claims data for the first half of 2023 (Figure 1).
The main pushback we’ve received against this view is that many US companies were super-keen to hire employees only six months ago, so they are unlikely to switch to cutting jobs so quickly. True, but what this argument misses is that US corporate profits look poised to fall sharply in the coming quarters.
Economy-wide corporate profits can be defined by a macroeconomic identity called the Kalecki-Levy Profits Equation, which equates profits to economy-wide consumption relative to savings:
Profits = Investment – Household Savings – Foreign Saving – Government Saving + Dividends/Share Buybacks
Using this equation, it is easy to see why US corporate profits have been so robust since the onset of the COVID pandemic. In 2020 – 2021, government spending vastly exceeded the increase in household savings that occurred during the pandemic. In 2022, as government spending receded, households drew on their savings, boosting consumption and therefore corporate profits too. However, these positive tailwinds for profits are now beginning to reverse:
All these factors suggest a negative outlook for US corporate profits in 2023. One rebuttal to this view is that profit margins are close to record levels, allowing room for them to come down without companies needing to slash employee headcount.
However, the US has had very low levels of productivity growth due to insufficient nonresidential investment over the past decade, meaning it won’t be so easy for many companies to maintain their margins. At the same time, companies with the highest margins have benefited from the market rewarding their stock prices relative to more cyclical businesses. Considering that market reaction, rather than take a hit to their margins, the more natural thing for management teams to do would be to just lay off employees — a trend we’re already starting to see in the tech sector.
Bottom line: We think many observers are underestimating the deterioration in the labor market that could occur due to worsening US profits in 2023. As a result, they may also be underestimating the severity of the recession that the US economy is likely to experience this year.
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Markets may be jumping the gun when it comes to expectations for a policy pivot and the likely risk-asset rewards. Members of our Investment Strategy team still see bumps in the economic road, though their outlook has brightened a bit when it comes to China and other emerging markets.
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Fixed Income Strategist Amar Reganti highlights credit market opportunities that he expects to arise over the course of 2023, against a backdrop of slowing growth.
Picture this: Our 2023 economic forecast in five charts
We explain the shifts the market is undergoing, analyze the implications for different asset classes, and identify potential risks and opportunities in a series of visuals.
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This executive summary distills the points of view of several of our 2023 Outlook authors. Discover the risks and opportunities they see as we enter a new economic and market regime.
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Our high-yield bond portfolio managers have a guardedly optimistic outlook on the market and believe security selection will be key to benchmark-relative outperformance in 2023.
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Looking ahead to 2023, members of our health care team see meaningful innovation, supportive valuations, and a benign political and regulatory backdrop across biopharma, medical tech, and health care services sectors.
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Cautious on global equity risk, Global Investment Strategist Nanette Abuhoff Jacobson suggests that investors favor higher-quality stocks and take a look at high-quality fixed income.
China’s economy: Poised to exceed expectations in 2023
With the bar set so low for China's economy, Macro Strategist Santiago Millan thinks it won't take much for an upside surprise in 2023.