Labor is ‘too hot’ for Fed, Stifel’s Bannister says. These industries hold the ‘defensive’ stocks in case of a recession.

In his view, “a recession signal is 4.1% unemployment,” which could arrive in December, implying an economic contraction in the first quarter of next year. In the meantime, Bannister said he sees the S&P 500 leveling at around 4,400 for the remainder of 2023, with rising real yields pressuring growth stocks, according to the note.

The S&P 500 closed Monday at 4,409.53, above both its 200-day and 50-day moving averages, according to FactSet data. The index has slipped so far in July after surging 15.9% during the first half of this year in its strongest first half of a year since 2019. 

In January, Bannister predicted the stock market could rally during the first six months of 2023 but warned trouble may be brewing in the second half of this year. 

See: ‘A year of two halves’: Stifel’s Barry Bannister expects a near-term rally in U.S. stocks — and trouble later in 2023

For the second half of 2023, Bannister said he prefers “cyclical value” over “cyclical growth.” 

Cyclical value includes areas such as banks, basic materials, capital goods, transportation, diversified financials, real estate, insurance and small-cap value stocks, he said, while describing cyclical growth as mostly “Big Tech.” That’s based on his view of rising real yields pressuring valuations and economic growth slowing without a recession this year. 

“Labor is just too hot, making it difficult” for the Fed to bring core inflation, as measured by the personal-consumption-expenditures price index, back down to 2%, said Bannister. “The Fed may have little choice but to weaken labor,” he said, estimating that in December the U.S. could see “an imminent recession signal flashing red.” 

Bannister said he is watching the unemployment rate’s three-month moving average as well as for it to potentially rise to 4.1% in December.

Cleveland Fed President Loretta Mester said Monday the central bank needs to raise interest rates further because inflation is now expected to be above the Fed’s 2% target for four years.

 Read: Fed’s Mester calls for slightly higher interest rates

Later this week investors will get a reading on inflation in June from the consumer-price-index, with CPI data scheduled to be released on Wednesday. The U.S. labor market has been resilient this year, with a low unemployment rate, despite the Fed aggressively raising rates since March 2022 in a bid to slow the economy in order to bring down elevated inflation.

The unemployment rate in the U.S. edged down to 3.6% in June, from 3.7% in May, according to a Labor Department report released on July 7. 

The Stifel report highlights the sensitivity of S&P 500 industry groups to economic growth and inflation, with Bannister noting that the bottom right quadrant of the chart below represents his preference in the second half of the year for “cyclical value” stocks. 

“Defensive value” stocks include areas such as utilities; commercial and professional services; food, beverage and tobacco; healthcare equipment and services; and energy, the chart shows. 

The report points to “defensive growth” equities including categories like pharma, biotech and life sciences; telecommunication services; consumer services; food and staples retail; and household products. 

The U.S. stock market finished higher Monday. The S&P 500
SPX,
+0.24%
closed up 0.2% higher, while the Dow Jones Industrial Average
DJIA,
+0.62%
rose 0.6% and the technology-heavy Nasdaq Composite
COMP,
+0.18%
gained 0.2%, according to FactSet data.