Everyone Feared Recession. His Data Said Otherwise | US Bank CIO Eric Freedman on What Comes Next

Key Concepts

• Controlling the Controllables: An investment philosophy focused on data-driven analysis of consumer behavior and business activity, rather than unpredictable policy decisions.
• Data-Driven Approach: Emphasizing empirical evidence and quantitative analysis, while incorporating intuition and experience.
• Mosaic Approach: Aggregating a wide range of data points to form a comprehensive view, rather than relying on single indicators.
• Marginal Change: Identifying and capitalizing on incremental improvements in economic or asset performance, rather than solely focusing on transitions from "good to excellent."
• Working Thesis: Maintaining a flexible hypothesis about future market movements, acknowledging uncertainty and allowing for adaptation.
• Strategic vs. Tactical Allocation: Differentiating between long-term, committee-approved portfolio constructs and short-term, CIO-driven adjustments.
• Consumer Scorecard: A proprietary metric used to assess consumer health across different cohorts, factoring in variables like delinquencies and borrowing conditions.
• Sticky Inflation: The persistence of inflation, particularly in services, which can embed expectations and influence central bank policy.
• Brazilian Steakhouse Analogy: A framework for understanding the bond market, where investors select "choice cuts" (issuance) and decide when to stop buying ("red card").
• "Cleanest Dirty Shirt" Analogy: Describing the US's relative strength in liquidity and military power, despite its own fiscal challenges.
• International Diversification: The strategic inclusion of non-US equities and fixed income in portfolios for diversification benefits.
• Real Assets: A category of investments that can include gold, silver, crypto, global infrastructure, and hydrocarbons, offering inflation protection.
• AI Framework (Phases 1-3): A structured approach to evaluating AI's impact, moving from strategy identification to credible implementation and ultimately, return on capital.
• Diffusion of Technology: The rate at which a new technology, like AI, becomes accessible and scalable across industries.
• Market Concentration: The disproportionate influence of a few large companies on overall market performance.
• Valuation: Assessing market levels in relation to earnings growth and productivity enhancements, considering both current and future return potential.
• Investor Discipline: The importance of having a plan and executing it unemotionally, especially during periods of market volatility.

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Investment Philosophy: Controlling the Controllables and Data-Driven Decisions

Eric, Chief Investment Officer at US Bank, outlines his firm's investment philosophy, centered on "controlling the controllables." This approach prioritizes a data-driven assessment of consumer behavior and business activity, rather than being swayed by unpredictable policy decisions or market sentiment. He references a late 1980s Journal of Science paper that highlighted the optimal outcomes in fields like finance arise from a blend of intuition, experience, and data. While acknowledging the value of intuition, the firm emphasizes data as the primary driver, especially in navigating periods where economic data and policy pronouncements diverge. This data-driven process involves analyzing a "large mosaic of information" to avoid reactive decisions based on emotion or gut feel, ultimately leading to better client outcomes.

Economic Outlook: A "Glass Half Full" Perspective Fueled by Data

Eric maintains a consistently optimistic outlook on the US economy, which he attributes to a two-pronged data analysis approach:

• Top-Down Macroeconomic View: This involves analyzing global data, including consumer and business metrics, surveys, and government and private data releases. A dedicated capital markets research team, led by Bill Murs, focuses on identifying "insightful and perhaps leading" indicators not just for the economy but also for asset prices, as investments are made in assets, not economies.
• Bottom-Up Corporate Perspective: Insights are gleaned from the equity management team, which analyzes company filings (10-Ks and 10-Qs) and identifies trends at the individual company and sector levels.

This combination of top-down and bottom-up information, gathered through frequent inter-departmental meetings, fuels the "glass half full" perspective. The team looks for "marginal change," identifying opportunities in transitions from "really bad to okay" or "okay to marginally better," rather than solely focusing on shifts from "really good to excellent." Examples of granular data points they monitor include box office receipts, TSA data, and restaurant cancellations.

Framework for Portfolio Construction: Strategic vs. Tactical Allocation

The implementation of investment ideas at US Bank follows a structured process differentiating between strategic and tactical allocations:

• Strategic Allocation: Any changes to the baseline construction of client portfolios (e.g., adding crypto, non-agency mortgages, or reinsurance) require a committee vote. This process is ingrained due to the firm's fiduciary obligation to clients.
• Tactical Allocation: These are ultimately the CIO's final call, operating within established boundaries set by committees. Examples include tactically adding to gold, mid-stream energy, or adjusting views on technology.

Eric uses the analogy of the UN Security Council, with permanent members (strategic) and temporary members (tactical), to illustrate this approach.

Navigating Recession Fears: Data Over Forward-Looking Indicators

Eric addresses the prevalent recession calls, attributing them partly to a lack of positive "gut feel" and partly to an over-reliance on forward-looking indicators like yield curve inversions or the Taylor rule. While these indicators are acknowledged, the firm prioritizes understanding "what's happening in the moment and what is likely to happen out 3, 6, 9, 12 months forward."

A key tool is their "consumer scorecard," which assesses consumer health on a scale of 0 (weakest) to 10 (strongest). In recent history, the weakest score was a 4, which, while not ideal, was accompanied by specific explanatory variables. A significant drop to a 2 or 3, coupled with rising delinquencies or weakening borrowing conditions, would trigger greater concern. The fact that the marginal improvement in the consumer score has actually increased in recent months reinforces their optimistic stance. Real-time data like TSA and box office figures also helped validate this view by not showing significant weakening.

Deciphering Conflicting Data and Consumer Behavior

The team acknowledges that conflicting data signals are common. For instance, company-specific information might suggest a shortfall in activity due to consumer behavior, but the analysis delves deeper to understand the type of consumer, product set, and whether tariff pass-through costs are the driver. This requires a top-down, bottom-up approach to achieve a "sharper focus."

The current consumer score is a 5 out of 10. While the holiday season is a focus, the outlook for Q1 of the following year is considered crucial. The post-COVID peak score was around an 8-10 in Q3/Q4 2021, driven by stimulus spending and a robust labor market. While the labor market remains decent, it's softer, and stimulus spending has wound down, explaining the current score of 5.

Inflation Outlook: Sticky Inflation and the Fed's Dilemma

Inflation is a significant concern, with the notion of "sticky inflation begets sticky inflation" being a key consideration. Economist forecasts for headline CPI through Q2/Q3 2026 remain around 3%, higher than in the rest of the world. Eric believes economists were initially too concerned about inflation and underestimated growth. While growth expectations have risen and inflation expectations have slightly decreased, the Federal Reserve faces a difficult position.

The Fed is balancing a softening labor market with persistent inflation. The potential for "embedded inflation expectations" is a concern. While the Fed aims for inflation with a "two in front of it" (e.g., 2.7%, 2.8%, 2.9%), current forecasts suggest headline CPI will remain around 3%. The dynamic between labor market and inflation concerns, coupled with the upcoming change in Fed Chair in May 2026, adds complexity. The desire for lower interest rates could also influence policy decisions.

The Bond Market: A Brazilian Steakhouse Analogy

Eric uses a "Brazilian steakhouse" analogy to explain the bond market. Investors are at a table with a green (want more) and red (full) card. Issuers present various "skewers" (municipal, corporate, government bonds, reinsurance, etc.). The challenge is to identify "choice cuts" and know when to stop.

The primary risk in the bond market, which is not yet apparent but could emerge, is twofold:

1. US Debt as the "Choice Cut": Historically, US government debt has been the preferred issuance. This could shift, indicated by bond auction performance and the 10-year yield.
2. Competition for Investor Capital: Other assets like gold, silver, crypto, global equities, and real estate are attracting investor interest, potentially diverting capital from traditional US debt.

The interplay between assets, inflation, and government issuance policies is a critical focus for bond market investors.

US Exceptionalism and Geopolitical Risks

While the US remains the "cleanest dirty shirt" in terms of liquidity and military strength, the firm respects the possibility of a shift away from US dominance. Geopolitical developments, such as unnatural partnerships (e.g., Saudi Arabia and Kazakhstan) and increased cohesion among countries like China, India, and Indonesia, present competition to the dollar and US Treasuries. This contrasts with the US's country-by-country, deal-by-deal approach. These dynamics have implications for asset classes and currency perceptions. The historical example of NAFTA and the decline of heavy industry in Eric's hometown illustrates how trade shifts can necessitate economic pivots.

International Diversification: A Strategic Necessity

US Bank advocates for international diversification, viewing currencies as largely a wash over time. Their focus is on local company exposure, acknowledging that indices can have biases (e.g., UK indices with a heavy banking and pharma presence). They maintain a strategic bias towards domestic equities and fixed income but recognize the diversification benefits of international exposure.

A positive trend is the increasing shareholder-friendliness of international companies, particularly in Japan and emerging markets. However, the firm remains mindful of the "wedge effect" between growth and the realization of shareholder value, which can be perpetual. This necessitates careful evaluation of shareholder protections, even in high-growth regions.

Inflation Protection: Beyond Stocks and Bonds

The firm believes in having "discrete inflation protection" in portfolios, disagreeing with the notion that stocks and bonds alone are sufficient. While they no longer have an outright allocation to commodity indices (like GSCI or Bloomberg Commodity Index) due to a dislike for futures-based exposure, they do hold exposure to TIPS (Treasury Inflation-Protected Securities) and real assets.

Real assets, on their platform, include gold, silver, crypto, global infrastructure, and hydrocarbons. They are particularly bullish on global infrastructure, citing its utility exposure (driven by data center buildouts) and its role in transporting hydrocarbons, which offers diversification and inflation hedging. Infrastructure contracts often have built-in inflation adjustments and generate income. While they appreciate the cash flow aspect, they acknowledge that gold and silver have performed well without this characteristic.

AI's Economic Impact: A Phased Approach

Eric views AI through a three-phase framework:

• Phase 1: Companies being asked if they have an AI strategy (yes/no).
• Phase 2: Assessing the credibility of AI strategies relative to shareholder-approved capital spending. The firm believes we are currently in this phase.
• Phase 3: Measuring the return on capital employed for AI investments. This phase is yet to be fully realized.

While AI is a transformative technology, its universal application is not yet proven. The code generated by AI can be flawed, making it unsuitable for applications with zero margin for error (e.g., medicine, critical finance components). The diffusion of AI technology in areas where a margin of error is acceptable is still in its early stages. Markets may not have fully recognized the scale of productivity gains AI can drive.

There's a risk of overextrapolation of AI's power in industries where errors have significant negative outcomes. The key will be separating "winners from pretenders." The current market environment is characterized by this discernment process. While AI is transformative, the market may be assigning too much value too early, similar to the dot-com era, though currently more contained. The potential for overbuilding data centers and spectrum licenses exists, but the firm is not yet at the point of determining that the market has gone too far overall.

Market Concentration and AI: A Cause for Pause

The concentration in the S&P 500, heavily weighted towards tech, is a concern. The argument that these companies generate free cash flow to fund AI projects is acknowledged, but the firm remains in the "between phase two and phase three" of AI adoption. The diffusion of AI technology, constrained by a limited number of chip producers and ecosystem players, is a significant factor.

The firm would become more concerned if the "Mag 7" continue to perform exceptionally well as diffusion increases and credible business cases become more defined. This could indicate a "beachball underwater phenomenon," where the market is not learning from past excesses.

Market Valuations: Fairly Valued with a Bias Towards Non-US Equities

US Bank views current market valuations as "higher side of fair." While they can justify current levels with falling front-end interest rates and potential productivity enhancements, they believe future returns might be pulled forward. They are not convinced that rates will fall significantly at the back end of the curve.

Consequently, they have a bias towards owning non-US equities, despite being overweight equities overall. This is driven by a combination of valuation and the notion of "marginal improvement" in markets like Japan. The CAPE ratio is considered a valuable tactical indicator, but a dogmatic adherence to it would lead to consistent underweighting of domestic equities. Their approach involves tight stops around target levels and a willingness to adapt based on market data, rather than rationalizing prices.

Key Investor Takeaways: Plan, Discipline, and Informed Consumption

Eric offers three core pieces of advice for average investors:

1. Have a Plan and Stick to It: This involves discipline, especially during volatile periods like the 11-15% intraday reversals seen on April 9th, 11th, and 12th. The plan must be interactive and engaging.
2. Be Unemotional in Execution: While easier said than done, minimizing emotional responses during plan execution is crucial.
3. Be an Informed Consumer and Empower Yourself: This involves actively seeking knowledge through podcasts, reading, and other resources. Crucially, it requires the ability to "separate good advice from bad advice" and be "parsimonious" with whom you follow, distinguishing between information overload and genuine knowledge.