Need to Know: Recession isn’t priced into stocks, says this $1.4 trillion fund manager that has just turned more cautious

Invesco’s global leading economic indicator has dropped below its long-term trend for the first time since the second quarter of 2020, when the world was first confronting the coronavirus pandemic, as both the U.S. and the developed ex-U.S. leading indexes have dropped for three straight months. They were dragged down by business surveys, housing indicators, industrial orders, consumer sentiment and labor market conditions in manufacturing — so basically everything, except maybe meme stocks.

Contraction regimes, Invesco says, last an average of 7 months but have run up to 15 months. During those periods, the average annual performance of U.S. stocks vs. the 10-year Treasury is -12%, with global equities performing an even worse -16%. Defensive factors outperform the broader by an average of 4%, Invesco says.

Markets, the firm adds, have largely not priced in a recession. The underperformance of stocks this year is almost entirely in line with the underperformance in 30-year government bonds
TMUBMUSD30Y,
3.136%.

“Broadly speaking, equity and credit markets have not discounted the additional underperformance due to lower earnings growth to be expected in a recessionary scenario,” said Alessio de Longis, senior portfolio manager and head of tactical asset allocation for Invesco Investment Solutions.

The firm sees parallels with the hot inflation of the 1970s and 1980s, although unlike those periods, inflation expectations are less severe and core inflation is not as high. “Our gauge of U.S. inflation momentum provides some early indication of peaking inflationary pressures over the past 3 months, but it is too early to judge the persistence of this negative momentum,” he added.

Its asset allocation recommendations reflect the increased caution — more toward bonds than stocks, toward U.S. than developed rivals and toward defensives from cyclicals.

The market

U.S. stock futures
ES00,
-0.71%

NQ00,
-0.81%
were weaker after the S&P 500
SPX,
+0.19%
finished at highest level on Tuesday since April 22. The yield on the 10-year Treasury
TMUBMUSD10Y,
2.868%
rose to 2.86%, and the real action was in the U.K., where gilt yields surged after an inflation surprise.

The buzz

The minutes of the last Federal Open Market Committee meeting are due at 2 p.m. Eastern. There’s already a gap between what Fed policymakers say they will be doing and what the market believes, so the question is whether the minutes widen this sizeable expectations gap or not.

Retail sales data for July is due for release, with expectations of minimal growth after a strong 1% gain in June. There’s also a $15 billion auction of 20-year Treasury securities.

Lowe’s
LOW,
+2.92%,
the number-two home improvement retailer, beat on earnings but missed revenue expectations. Target
TGT,
+4.57%
recorded a far worse than forecast second-quarter profit, but didn’t change its sales forecast for the year. 

Elon Musk tweeted he was going to buy Manchester United
MANU,
+0.08%,
the struggling English soccer giant, then said he was joking.

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The chart

CEOs have not been this pessimistic since the start of the pandemic, according to a quarterly survey from The Conference Board in collaboration with The Business Council. Some 81% said they were preparing for a brief and shallow U.S. recession, with 12% expecting a deep recession and 7% not anticipating any recession at all.

Top tickers

Here were the most active stock-market tickers as of 6 a.m. Eastern.

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