'No recession bet whatsoever': The stock market isn't pricing in any sort of economic downturn, investment firm says

The Leuthold Group reports that investors are pricing in minimal recession risk, evidenced by the S&P 500 Cyclical/Defensive Ratio hitting an all-time high of 1.19 in May, indicating a 19% premium for cyclical stocks; this contrasts with historical patterns where defensive stocks traded at a premium before recessions. Despite recession odds falling from 66% to 28% after tariff pause announcements, strategists note the market's pricing may be overly optimistic given that a 28% chance of recession remains elevated compared to the long-term average.

Analysis

Market positioning, as analyzed by The Leuthold Group, indicates a significant investor conviction in sustained US economic growth, with equity managers largely dismissing recessionary risks. This is underscored by the S&P 500 Cyclical/Defensive Ratio attaining an all-time high of 1.19 in May, reflecting a 19% valuation premium for cyclical stocks over defensives; this ratio has remained elevated, above 1.05 and in the top 10% of historical readings, for 13 consecutive months. Such pricing starkly contrasts with historical patterns preceding recessions like 2000, 2008, and 2020, where cyclicals typically traded at an average 25% discount to defensives. Although prediction market recession odds have decreased from 66% to 28% post-tariff pause announcements, this 28% figure is still well above the circa 15% long-term average and is viewed by The Leuthold Group as inconsistent with the market's aggressive cyclical tilt. Concurrently, defensive stocks now trade at a 10% discount to the S&P 500, a departure from their historical premium, suggesting they could offer relative value and a potential rebound should recessionary concerns, including stagflation warnings from figures like Apollo's Torsten Sløk and JPMorgan's Jamie Dimon, intensify.

Key Decisions for Investors

• Investors should closely monitor the S&P 500 Cyclical/Defensive Ratio for any signs of reversal, as a shift towards defensive premiums could signal rising recessionary concerns and a potential market rotation.
• Given the current high valuation of cyclical stocks relative to defensives and the lingering, albeit reduced, recession probability, it may be prudent to re-evaluate exposure to cyclical sectors and consider the relative attractiveness of defensive stocks, which historically outperform during economic downturns.
• Maintain vigilance on macroeconomic indicators and expert commentary regarding inflation and growth, as the divergence between current market pricing and underlying economic risks, including a 28% recession probability, warrants cautious portfolio positioning.