- Jason Vaillancourt, a strategist at Putnam Investments, is no longer bullish on stocks.
- High inflation will weigh on consumer spending and could cause a recession in the next year.
- Here’s how to invest in commodities to hedge risk in a late-cycle investing environment.
Not long ago, Jason Vaillancourt was bullish on stocks. Now, the global macro strategist at Putnam Investments believes an economic downturn is probably coming in the next year.
“It’s definitely better than a coin flip at this point,” Vaillancourt said of a
in a recent interview with Insider. “In general, as a firm, we think recession is quite a bit more likely than consensus expects in the next 12 months.”
One of the biggest reasons why Vaillancourt has downgraded his outlook on equities to neutral is the threat of surging inflation.
Headline inflation is currently at four-decade highs, and while Vaillancourt said it may ease after possibly peaking at 8.5% in March, he cautioned that another common indicator of price growth, Core PCE, remains abnormally high at 5.4%. Shelter prices, which the strategist noted make up a large part of the Core PCE, are still “nowhere near” their apex, he said.
Higher prices inevitably hurt customers, companies, or both — depending on if businesses can pass on price hikes. Corporate profit margins, which Vaillancourt noted have steadily grown for years as taxes and interest expenses fell, will be under heavy pressure in the Q1 earnings season, the strategist said. Shares of firms without pricing power will likely get punished.
But while demand destruction and profit margin erosion are serious headwinds, there’s a sense among some economists that inflation only poses an indirect threat to the economy, and that it’s the risk of a policy error from the Federal Reserve that should cause investors to lose sleep.
The US central bank has long dismissed inflation as “transitory,” or temporary. But Fed chair Jerome Powell has done a 180 in recent months and made it clear that the Fed has made stopping inflation its top priority, even if doing so hurts economic growth.
“Essentially, Powell has told you what their reaction function is, which is they will actually sacrifice growth for the sake of bringing inflation down,” Vaillancourt said.
Consumers appear to be healthy, but looks can be deceiving
Central bankers insist that their policy pivot to tackle inflation at all costs is justified because the US economy is so strong, and they aren’t alone. Market experts like Bob Doll, the CIO at Crossmark Global Investments, have been comforted by historically low unemployment and healthy consumer balance sheets that have led to robust spending in the face of higher prices.
On the surface, it appears that the two-year-old economic expansion is indeed on stable footing. The Consumer Confidence Index (CCI), a widely followed survey that gauges consumer sentiment, is historically elevated, and consumer spending accounts for about 70% of US GDP.
But in February the Consumer Sentiment Index, a well-respected survey conducted by the University of Michigan, plunged to a level last seen during the great financial crisis. While it’s worth noting that while the sentiment index rebounded by 10.6% month-over-month in April, the readings were still down by 25.6% year-over-year.
“When you see two pieces of soft data that historically are very highly correlated, that almost always behave exactly the same — when you see a big divergence between them and they’re no longer behaving the same, that should cause you to ask some questions,” Vaillancourt said.
The dispersion between what are typically two tightly intertwined surveys is highly unusual, but it’s not unexplainable.
The Conference Board’s survey is heavily influenced by the labor market, Vaillancourt noted, so it makes sense that it’s showing strength, given the plethora of available jobs and remarkably low unemployment rate of 3.6%. The University of Michigan’s index, however, is broader and likely better reflects the sky-high inflation that’s weighing on consumers, the strategist said.
Surveys and other forms of soft data are imperfect because there can be a difference between what people say and how they act, Vaillancourt said.
But there’s a question on the University of Michigan’s index that he found to be a particularly accurate predictor of future consumption that asks if it’s a good or bad time to make large household durable purchases. The percentage of respondents who said it was a poor time to buy big items, like cars and appliances, was the highest it’s been since 1978, Vaillancourt said.
“The pandemic stimulus pulled forward a lot of that demand for those things, and we’re seeing that now that that demand is kind of falling off,” Vaillancourt said.
A sharp demand dropoff should be buffered by what appear to be robust consumer balance sheets, but Vaillancourt said that what looks to be a strong US economy may instead be a mirage.
“If you actually break down the US by demographic, by income quintiles, almost all of that cash and almost all the benefits from that have resulted from the increases in financial asset prices over the last 18 months,” Vaillancourt said. “And that all accrues to the top fifth of US households by wealth.”
Vaillancourt continued: “Real wage growth is actually negative now because of inflation. That’s gonna have a really big impact on the bottom four-fifths of the income distribution. And that, to me, is where the big risk is. And it’s being masked by just looking at the averages, at the aggregate numbers.”
How to invest in the late stages of an economic cycle
If Vaillancourt is correct that high inflation will hurt consumer spending and cause a recession in the next 12 months, investors should tread carefully. Adding exposure to commodities, which tend to fare well in inflationary environments and can also be considered defensive assets, is Vaillancourt’s top investing idea right now.
“We’ve essentially come out of the pandemic almost exactly where we were before it, which is pretty late in the cycle,” Vaillancourt said. “And so traditionally, the late-cycle investing playbook tends to be pretty bullish on commodities.”
Maintaining a balanced basket of commodities is wise, Vaillancourt said, but he added that riding the energy sector’s momentum may be especially prudent in the next few months.
“The early part of the late-cycle — that tends to be pretty energy-intensive,” Vaillancourt said. “But as you kind of get later and later in the cycle, I think that broadens out to other things. So energy costs and energy pressures ultimately feed through into things that require the use of energy.”
“Higher energy costs have meant higher fertilizer prices,” Vaillancourt said. “Higher fertilizer prices ultimately result in higher food prices.”
Precious metals, however, are one subgroup within commodities that Vaillancourt said he’s no longer crazy about. Central banks hiking interest rates makes having a hedge against government-issued fiat currencies less urgent, the strategist said, which means gold isn’t as enticing for investors. However, Vaillancourt did say that miners are still worth considering.
While Vaillancourt declined to issue specific investing recommendations, Insider compiled a list of exchange-traded funds (ETFs) based on the ideas he shared.
Several ways to play the energy sector include the Energy Select Sector SPDR Fund (XLE), the SPDR S&P Oil & Gas Exploration & Production ETF (XOP), the iShares MSCI Global Energy Producers ETF (FILL), and the Invesco Dynamic Energy Exploration & Prod ETF (PXE).
Funds with exposure to commodities include the iShares U.S. ETF Trust iShares GSCI Commodity Dynamic Roll Strategy ETF (COMT), the Invesco DB Commodity Index Tracking Fund (DBC), and the United States Commodity