(Bloomberg) -- A stock rally that lasts for too long at this stage could be “dangerous” as it would ease financial conditions, boost inflation and push the Federal Reserve to keep tightening, according to Seema Shah, chief global strategist at Principal Asset Management.
“There is clearly a little froth in the market,” Shah said on the What Goes Up podcast. “We would anticipate that there’s going to be a bit of a pullback. Once you get that pullback, increase your exposure because I think this is a long-term trade.”
Shah also noted that the next six months “could be very, very choppy for a lot of things in the market.”
Here are some highlights of the conversation, which have been condensed and lightly edited for clarity. Click here to listen to the full podcast, or subscribe on Apple Podcasts or wherever you listen.
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Q: You say a recession isn’t imminent, but you are forecasting one. Tell us more.
A: We are still expecting a recession. We’re maybe increasingly in the minority in actually expecting a full recession to come through, but we are expecting it starting Q4. I know a lot of people out there who are expecting recession expect it to come in Q3. I look at the labor market, the strength of it, and I say that’s almost impossible. By Q4, we would expect fairly mild negative growth, and then in Q1, a deeper downturn. But then by Q2, this is back to recovery. So this is historically a very short recession and historically a very, very mild recession.
Q: How have your views shifted from the beginning of the year to now?
A: We have had this expectation for recession in the second half of 2023 since the early part of 2022. So this is a long-held view for recession and really based on this idea of the long and variable lags — all based around Fed policy is going to trigger recession.
In the last two or three months, with this continued strength of the labor market, the one thing that we have changed is that we have reduced the duration of a recession from three quarters to two quarters. I almost wonder if this is even going to feel like a recession. If you look around, are you going to say, ‘Wow, the US is in a recession?’ Probably not because it’s that mild. So I think maybe the more important part of this, at least from an asset-allocation perspective, is what the impact on earnings is going to be. And you can already see in that downward trend, you get into recession, earnings will continue to come down and that’s really what’s going to weigh on asset prices. But certainly if you look at the labor market and what we’re expecting, we’re projecting unemployment to rise to 4.1% by year-end. That is still essentially full employment. So it’s not, I don’t think, going to be a very, very tough recession for the population.
Q: AI stocks have been all the hype of late. How resilient are AI-linked stocks from any potential recession and earnings downturn?
A: They are fairly resilient to the broader economic story, simply because they are typically the companies that should thrive when things get a little bit more challenging.
It’s not like they’re going to completely avoid the downflow that you see for the broader economy, but I would expect them to outperform. The reason I’m hesitating is because there is clearly a little froth in the market — valuations have just gone to extreme levels. We would anticipate that there’s going to be a bit of a pullback. Once you get that pullback, increase your exposure because I think this is a long-term trade. But I do think that maybe the next six months could be very, very choppy for a lot of things in the market.
The other thing is if you don’t see a pullback in the market, at least a pullback on the AI side, does it drag the rest of the market up with it? Do you get this melt-up, this momentum, this improved investor sentiment? And I think that would be dangerous because all that happens then is that you get liquidity, financial conditions continuing to ease, you get a new re-burst of inflation, kind of like what you saw in the 1970s. You get new Fed hikes to come and then you essentially get a deeper downturn. So from a recession standpoint, you want to get this out of the way sooner. The later it comes, the deeper it’s going to be.
--With assistance from Stacey Wong.
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