Why a Slowdown Might Not Be Too Bad, CIOs Say

If the U.S. should fall into a recession, there are many strong points in the economy to mitigate any pain. That was the thrust of a webinar held by Franklin Templeton, featuring CIOs from three of the investment house’s subsidiaries.

Whether a slowdown or a full-blown recession occurs, some kind of deceleration is likely, according to Scott Glasser, CIO of ClearBridge Investments; Ed Perks, CIO of Franklin Income Investors; and Michael Buchanan, co-CIO of Western Asset Management Co. Admittedly, the trio observed, a recession has been forecast for a long time and has not materialized—and indeed gross domestic product growth was up year-over-year by 4.9% in the third quarter.

“Corporate health is solid,” Glasser noted. “Earnings have held up.” At the same time, he acknowledged that they likely will not stay at current high levels, with 2.3% growth expected for the full year. He said he expects the figure to come in at half that and also pointed out that, for small companies, the picture is not as rosy, with 40% of the small-cap Russell 2000 not profitable.

Still, corporate cash this year is at an all-time high, said Buchanan: “Balance sheets are in good shape.” A lot of company bond and loan refinancing occurred in recent years, when interest rates were very low, and that debt will come due in the next few years, with rates higher, but not high enough to be worrisome, he added.

Ticking off the indicators of a possible recession, Perks said the inverted yield curve—a longstanding warning sign of bad times ahead—has flattened lately, with yields clustered around 5%.

So what is the better route for investors, fixed income or equities? Perks pointed to fixed income due to how much yields have risen: “You’re getting paid a lot more today,” he said. Investment-grade bonds average 6.5% annually and high-yield 9.5%, with average bond prices at 85 cents on the dollar.

At the same time, if the Federal Reserve has finished tightening and yields do go down, bonds with lengthy durations will flourish in price terms, Buchanan said: “That’s a good time to own them,”

Meanwhile, owing to the narrow breadth of the stock market, with shares of the five biggest capitalized companies occupying 25% of the S&P 500, the average stock is flat for the year, Glasser said: “They haven’t done much.”

That said, whatever the degree of an expected slowdown, higher quality debt should be the way to go, in Buchanan’s view. A reassuring factor is that lower-rated investment-grade bonds, namely those at BBB-, are thought to be in good shape, with only 12% having a negative outlook regarding possible downgrades to junk, he said.

“A lot of lessons were learned” from the financial crisis of 2008 and 2009, Buchanan went on. Thus, he concluded, companies are more careful about risk nowadays.