AOR Update (Podcast): Jevons paradox predicts no AI “job apocalypse”

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Podcast transcript

Host/John Przygocki: Welcome to Talking Markets with Franklin Templeton. I'm your host John Przygocki from the Franklin Templeton global marketing organization. As a forward-thinking asset manager, Franklin Templeton leverages cutting-edge strategies and deep industry insights to unlock opportunities to help grow wealth. We're your trusted partner for what's ahead. I'm here today in the studio with ClearBridge Investments Head of Economic and Market Strategy, Jeff Schulze.

ClearBridge is an equity manager offering a broad range of strategies across global markets. And Jeff is the architect of the Anatomy of a Recession program, a program designed to provide you with a thoughtful perspective on the state of the US economy. Jeff, welcome to the show.

Jeff Schulze: Glad to be here, John.

John Przygocki: Jeff, let's start with the US economy. The US economy appears to be hanging on despite the uncertainty in the Middle East, with first quarter gross domestic product coming in at about 2% annualized. What were your key takeaways with that release?

Jeff Schulze: Well, John, it was a really good print, all things considered. You mentioned 2% annualized, but a 1.3 drag you saw from stronger imports. My takeaway is that that's showing firm domestic demand.

Consumption hung in there. Capex is strong. And something that I've mentioned on this podcast before that we like to look at, which is a core GDP concept. It's called final sales to private domestic purchasers. It strips out things like inventories and net trade, government spending. That came in at a healthy 2.5%. And when you look at GDPNow by the Atlanta Fed, which is a “nowcasting” tool, it shows that if second quarter GDP was released today, it would come in at 4%.

And of that 4%, about half of that is consumer spending. And another percentage point of that is capex, or business investment. So, although there is a lot of concerns about the Middle Eastern conflict and higher energy slowing the US economy, you're just really not seeing it in the data as of yet.

John Przygocki: Jeff, you've been consistently optimistic about the US economy, given the output of the ClearBridge Recession Risk Dashboard over the past year. Were there any indicator changes this month?

Jeff Schulze: There were, and I'm very pleased to welcome back our Housing Permits indicator. That was the final dashboard indicator that's been unavailable due to data delays from the government shutdown in the fourth quarter of last year. So, when we got housing permits back, it actually was upgraded to green from the yellow reading that it had when those data disruptions began.

So, when you look at the 12 indicators, ten of them are green right now. We have one yellow caution and then one red recession indicator. But this is a dashboard that's consistent with recession odds of only 20% over the next 12 months. Now, given the uncertainty with the Middle East and how long these disruptions are going to occur for, we've nudged that higher to 30%.

But the key takeaway, just like we're seeing in the GDP numbers, is that this is a healthy economy with a firm foundation.

John Przygocki: The April payroll release came out a couple weeks ago. A couple questions here. First, what were your key takeaways from that release, and are there any other important labor data points that have caught your eye this month?

Jeff Schulze: Well, it was a pretty strong print, and I think it clearly shows that the economy is on a pretty solid trajectory at the moment. Now, we got our first back-to-back positive payroll gains in over a year. And what's gotten me very excited is that when you look at private payrolls over the last four months, they've averaged 86,000 per month, which is the strongest four-month pace that you've seen since 2024.

So, job creation has reaccelerated, and it's a lot broader than what we saw last year. A stat that we find is pretty shocking is that when you look at 2025 and you strip out health care- related jobs, the economy created negative 271,000 jobs last year. This year so far, ex. health care, the labor market has created positive 153,000. So, you're seeing broader labor breadth and you're seeing stronger private payroll creation, which is a really good dynamic. And it gives us confidence that the labor market has taken a turn for the better.

And the last stat that I'm going to throw out at you: our economic canary in the coal mine, which is Initial Jobless Claims, the best indicator that we have on the dashboard. A couple of weeks ago, we saw the lowest reading of that data set since 1969. And back in 1969, the labor force was only 70 million people, compared to 160 million people today. So, we think that the labor market has firmed and is on a much better footing than what we've seen over the last year and a half.

John Przygocki: Jeff, you have said repeatedly on this podcast that you don't believe in the job apocalypse mantra regarding artificial intelligence, or AI. Are there any interesting data points that you've come across recently on this topic?

Jeff Schulze: Well, there's a view that AI is disrupting younger people going into the labor market, but youth unemployment rates have fallen recently. When you look at the 16- to 24-year-old unemployment rate, it's fallen to 8.5% from more than 10% at the beginning of this year. So that's a positive dynamic that kind of flies in the face that AI is having massive disruptions.

Another thing that we think is interesting is that ground zero of AI disruption is the software space, and software development job openings have risen by double digits over the course of the last year. And software development wage growth has accelerated in the second half of last year.

So, we continue to believe in Jevons paradox: that AI will ultimately create more employment because it's going to lower cost. But you know, when you think about this AI job apocalypse narrative, you know, I don't think it's going to create huge disruptions in the labor market, but it will prolong this low-hire, no-fire environment that we've seen as companies are doing more with their existing workforce.

John Przygocki: Jeff, you just mentioned something called Jevons paradox. Can you explain to us what that means exactly?

Jeff Schulze: So, Jevons paradox was something that was brought forward by an economist, William Jevons, in the mid-1800s. He observed that improved steam engines used less coal per unit of work. And the thought was that you're going to see a lot less coal consumption, but because you were getting much more efficiency out of those steam engines, it made them more popular. And total consumption increased in England.

So, you know, usually when you have a new technology, yes, that efficiency makes those resources or services cheaper. It doesn't lead to less employment or less demand. It actually does the reverse of that, counterintuitively.

So, you can see that with cars, right? When you've had better fuel efficiency, it led to people driving more. LED lights. As lighting has become more efficient and became cheaper, you use more lights.

And when you kind of think about this from an occupational standpoint, if the different tasks of lawyers or accountants or consultants, those costs of doing those tasks go down, things are going to get cheaper, and it's going to open up more demand to people that previously weren't using those services. So, one thing that we've noticed is that the number of new businesses created every week is at the highest levels in US history, and we think a big reason for that is a lot of startups can now compete with more established firms on certain tasks because AI is bringing down the cost of those tasks.

So, you know, I think that we're seeing Jevons paradox, and I think we're going to continue to see that moving forward, which will fly in the face of this job apocalypse narrative that you hear constantly about.

John Przygocki: So, Jeff, there is fear out there in the market that we are on the verge of another bout of stagflation. Do you agree that stagflation is on the way?

Jeff Schulze: Well, when you think about the word stagflation, it's a combination of two words, inflation and then stagnation, which is usually associated with sluggish or negative GDP growth and high unemployment rates. So, we're really missing the stag portion of stagflation. So, yes, we're going to see an increase of inflation. But I think fears of stagflation are overblown because of that growth portion of that environment that you would typically see in a stagflationary world.

John Przygocki: Jeff, Kevin Warsh is going to be the next Fed chair. Does a Warsh-led Fed look different than the one under Powell?

Jef Schulze: It will look different. Kevin Warsh has talked about being more forward-looking when providing rate cuts, being more anticipatory rather than reactionary. The Fed right now is pretty data dependent, so they’re reactionary. That is his basis for more cuts because he sees a productivity boom coming from AI.

He also wants a meaningfully smaller balance sheet. He left the FOMC back in 2010 because he disagreed with QE2. And he also wants to rein in Fed communication, because he thinks that the Fed overcommunicates and it boxes them into a corner. But, when you put all this together, it's important to realize that, yes, he wants these different things, but the FOMC is a committee and not just a chair.

And Warsh is going to have to build consensus, which is going to limit the changes of how he wants to either communicate from the Fed or the changes in policy that he wants to institute.

And, you know, the biggest concern for investors with Kevin Warsh was he was a balance sheet hawk. He wanted a materially lower balance sheet. But it's important to realize that just six months ago, you were seeing disruptions in short-term funding markets. And the Fed instituted reserve management purchases, which is a minor form of QE. So, you know, even if he does build consensus, there's going to be limitations on how much lower the balance sheet can get.

John Przygocki: Jeff, I've got a follow up there. During his confirmation hearing, Kevin Warsh highlighted trimmed mean and median inflation as potentially better measures of trend inflation than the measure that the Fed currently focuses on, which is core PCE. Is there any merit to that argument?

Jeff Schulze: There is some merit to that argument. When core and trimmed mean inflation have performed pretty similarly in being able to predict inflation a year ahead, median inflation really has performed worse. So, it's really a trimmed mean story.

And I think as long as Warsh remains consistent with trimmed mean or median in his gauging of the inflation picture, that's the most important piece, because right now median and trimmed mean are lower from an inflation standpoint than core PCE, which provides the impetus for potential cuts down the road. And if you flip flop between which measures you're going to use based on what narrative you want to paint, that creates a perception that the Fed's credibility is potentially compromised.

So, I think there is some merit in using trimmed mean as an alternate means of core PCE. But, again, that is going to have to be consistent as we look forward.

John Przygocki: Market participants have fully priced out the cuts from fed funds futures this year and are currently pricing in one and a quarter hikes by April of 2027. Do you agree with this pricing, and can the market do okay if the Fed does not cut further?

Jeff Schulze: The market tends to price in more hikes. And just today that's been nudged up to one and a third. And I think that that's a little bit too hawkish. I think we're probably going to get a resolution in the Middle East, which will allow the Fed to likely cut over the course of the next 12 months. So, I think a cut is more likely than a hike when you're thinking about Fed policy.

But more importantly, I don't think a rate hike or rate cut is really moving the needle much for the markets. If you have neutral Fed policy and you have above median earnings growth, which is above 8%, it has been a very productive environment for equities. Average returns in these environments is still north of 16%.

So, I don't think it really matters if we get one hike or one cut. I think the markets are going to continue to move forward because we've had really strong earnings delivery, and nothing that I've seen over the course of the last quarter or two is changing that view.

John Przygocki: So, Jeff, 10-year Treasury yield spiked last week and crossed over 4.5%. What does this mean for equities? And where do you think long yields will ultimately settle?

Jeff Schulze: Four and a half percent on the 10- year Treasury has been the line in the sand where it's really created anxiety for equities. And with the 10-year Treasury close to 4.7%, it's not a surprise that you've seen some choppiness out there.

But, you know, as we do hopefully get a resolution to the war, I think you will see 10-year Treasury yields start to move lower, which will be a tailwind for valuations and the stock market. And the reason why I say that is when you go back to 1990 and you look at the aftermath of a major peak in Brent crude, fairly consistently on a three-, six- and 12-month basis after that peak, 10-year treasuries have dropped.

And the one exception to that was in May of 2022. But when you think back to four years ago, very different environment than where we currently sit. A lot of people forget that the 10-year Treasury was below 1% at one point in 2021, right? So, the 10-year Treasury was normalizing. The Fed was hiking in 75-basis-point chunks. Inflation was moving dramatically higher because of supply chain disruptions. And you had all that pandemic stimulus. And you had a really tight labor market. That is not the environment that we have today. So, I think once we get visibility in the Middle East, the 10-year Treasury will drop, likely down into the low 4% range, which again should be a tailwind for US equities.

John Przygocki: We're pretty much through first quarter earnings season. What are your key takeaways?

Jeff Schulze: Well, I think this is a really strong earnings season. Earnings came in at 28%. Revenues were double digits. And every sector reported revenue growth that exceeded expectations at the start of the quarter. So, it's been broad-based strength. And it really just underlines how resilient the economy has been at the start of the year.

Furthermore, guidance was broadly positive. The revenue surprise was double almost what you typically see. And it really wasn't just a Mag Seven story. When you look at the S&P 500 [Index], the median stock surprise was 6%. The median stock delivery on a year-over-year basis was 12%. And both of those are the best that you've seen in over four years.

It's remarkable that you've seen earnings delivery this strong, because typically you only get to these levels coming off of the lows of recessions. And that's clearly not the environment that we’re in. So, it was a strong quarter for US earnings delivery. And from everything that I've seen and the guidance that was provided, I think we're going to be able to build on this as we move further into 2026.

John Przygocki: So, Jeff, the US midterm elections are this year. And, historically, the period leading up to the midterms has been a tough one for investors. Are you expecting a big drawdown that's consistent with history?

Jeff Schulze: Well, I think we've already had the drawdown. Usually when you're looking at midterm seasonality, you see a lot of choppiness in Q2 and Q3. But I think that we pulled that forward with the Iran war in Q1.

And I ultimately think that the business cycle trumps the seasonality that you see with midterm elections. Another reason why I'm positive is that, again, earnings delivery is just much stronger than what you typically see during midterm election years. Usually, it's around mid-single digits. Expectations for 2026 are now 22%.

So, you know, that's a reason for being constructive. And I think a second reason is that we had almost a 10% drawdown in the month of March. It's very rare to see two 10% drawdowns in a given year. When you go back to 1970, it's only occurred five separate times. So, I think we pulled forward a lot of this volatility. And if we don't get a resolution in the Middle East, maybe we get some choppiness, maybe we get a 3 to 5 or maybe even 7% pullback. But we're buyers of that dip given the strong earnings environment that we have currently.

John Przygocki: Jeff, we've seen quite a rally off the late March lows for the S&P 500. Are the markets ahead of themselves with P/Es for the S&P 500 now back above 20?

Jeff Schulze: There's an old adage out there that the market waits for no one, right? If you had clear visibility, that's already in the price of equities. And the markets are anticipatory. And that's exactly what they've done this time around.

So, while you may again see some volatility, depending on how things develop in the Middle East over the next couple of weeks, I don't think that the markets are ahead of themselves, especially with that strong fundamental earnings environment that I just talked about.

Now, you mentioned valuations. Valuations have been high, and we think they're going to continue to be high. If you go back to the first time in this expansion where the P/E of the market was above 20, that was in April of 2020. So, it's six years ago. Over the last six years, you've had valuations above that 20 threshold two-thirds of the time.

But I think, more importantly, over that same six-year period, the S&P 500 has returned roughly 150%. Almost all of that has been driven by earnings. So, I think we're in a higher valuation regime. That's nothing to be scared of. As long as that earnings delivery continues to be strong and that picture doesn't deteriorate, I think the markets continue to melt higher from here.

John Przygocki: One last question before we get to a closing thought. What is the key risk for the market at this point?

Jeff Schulze: I think it all stems from the Middle East. You know, if we do not get a resolution and you continue to see supply disruptions, energy prices are going to go up materially higher from where we currently sit. That's going to create a drag: inflation moving higher, rate hikes being priced into the market, 10-year Treasury and long bonds moving up further, which will ultimately pressure valuations, bring down growth and potentially dent that optimistic earnings scenario that is my base case at the moment.

Now, I do think that the administration will find an off ramp, because affordability is the number one concern of voters. The University of Michigan's consumer sentiment survey just last month saw its worst reading in over 75 years. So, I do think the incentives are there. But the longer that this energy crunch continues, the more volatility and potential downside that you will see in US equities.

John Przygocki: All right Jeff, as we bring today's conversation to a close, how about that closing thought for our listeners?

Jeff Schulze: As I mentioned in the last podcast, there's a big wall of worry that's out there. You have fears about the job apocalypse. You have fears about the energy situation in the Middle East really hurting economic growth in a material way. We didn't talk about it this podcast, but there's fears of over-investment with the AI capex cycle, high valuations.

And, you know, what we found throughout time is that bull markets climb that wall of worry. And, yes, there's a lot of skepticism out there. But skepticism is the foundation of a bull market rather than a hurdle. And right now, with the markets near an all-time high, believe it or not, when you go back to 1989 and you look at the total return of the S&P 500, if you had bought at an all-time high compared to below an all-time high, you would have had a better forward one-, three- and five-year returns investing at the all-time high.

So, an object emotion tends to stay in motion. And given the backdrop that we have from an earnings perspective, you know, we think that dips are meant to be bought. And we think the market will continue to melt higher as we move through this year.

John Przygocki: Jeff, thank you for this month's update. To all of our listeners, thank you for spending your valuable time with us today. If you'd like to hear more Talking Markets with Franklin Templeton, please visit our archive of previous episodes and subscribe on Apple Podcasts, Google Podcasts, Spotify, or just about any other major podcast provider.