Recessions never happen when they’re expected, so investors should hold their nerve
- Nicholas Spiro says fears of a recession are mounting in the media and among investors, and such worries could be self-fulfilling if they ignore the data that is more encouraging
On Tuesday, Germany’s Federal Statistics Office announced that industrial production in Europe’s largest economy contracted in November by 4.7 per cent year-on-year, the sharpest fall since 2009 and the latest in a string of weak data that has increased the risk Germany suffered a technical recession – two straight quarters of negative output – in the second-half of 2018.
Other leading economies in Europe are also slowing. Italy is on the verge of a recession while France suffered its first fall in economic output in 2½ years last month due to weeks of disruption caused by the “yellow vests” protests about falling living standards. In China, the epicentre of the global growth scare, manufacturing activity is contracting, car sales have declined for six consecutive months and industrial profits are falling for the first time in three years.
However, markets are most concerned about the US economy, which is enjoying its second-longest expansion on record. A gauge of manufacturing activity last month fell at its fastest pace since 2008, suggesting that the trade war and the diminishing tailwind of President Donald Trump’s tax cuts are starting to take their toll. The slowdown is most evident in corporate America, with a slew of high-profile companies, including Apple and Delta Air Lines, cutting their revenue forecasts due to pressures on profit margins.
According to data from Bloomberg, the R-word has become much more prevalent in news articles. By the end of last year, occurrences of the word “recession” in stories on the Bloomberg terminal had reached their highest level since the start of 2017.
Investors have begun to panic, as evidenced by the dramatic sell-off in stocks and corporate bonds in the final quarter of last year. According to a report by JPMorgan published last Friday, when markets reopened following the Christmas holidays, the benchmark S&P 500 index was pricing in a 60 per cent probability of a US recession within the next year. The pessimism, JPMorgan notes, has become extreme.
This is because many of the prerequisites for a recession are still missing. The banking sector, particularly in the United States, is in a healthier state than in the run-up to the 2008 crisis, while there is no systemic risk, usually defined as a major shock that triggers a loss of confidence in the financial system and damages the real economy. On Tuesday, the World Bank published its latest forecasts which show that global growth will reach 2.9 per cent this year, a decrease of just 0.1 per cent from its estimate last June.
The problem is that growth is no longer beating the expectations of analysts and investors, as was the case in 2017. According to Citigroup’s closely watched Economic Surprise Indices – which measure how often data comes in better or worse than expected, rather than how well economies are performing – all the major regions and countries are now in negative territory. This is fuelling uncertainty in markets, blurring the line between an economic slowdown and an outright recession.
It is only the severity of the former that is at issue. A mere 9 per cent of respondents to last month’s Bank of America Merrill Lynch fund manager survey expect a global recession this year. Still, if asset prices keep reflecting the increased likelihood of a recession, there is a significant risk that economic fundamentals will deteriorate further, creating a negative feedback loop between markets and the real economy.
The good news is that recessions rarely materialise when they are widely anticipated. The fact that investors are fretting about a sharp downturn makes it less likely that one will occur. What is more, policymakers are becoming more sensitive to weaker growth. Last Friday, Federal Reserve chair Jerome Powell triggered a fierce rally in markets by promising a “patient” approach to tightening policy. The European Central Bank, meanwhile, has made it clear it is in no rush to begin raising interest rates after ending its asset purchase programme last month.
The bad news, on the other hand, is that central banks themselves have become sources of volatility and have run out of ammunition following years of ultra-loose policy. The Fed is unlikely to cut rates this year – which is what markets are currently pricing in, according to data from Bloomberg – and may still raise them again if growth remains sufficiently buoyant. Should recession fears become more acute in the coming months, concerns about the adequacy of the policy response will intensify, putting markets under renewed strain.
This is all the more reason for investors to hold their nerve, lest all the talk of recession becomes a self-fulfilling prophecy.
Nicholas Spiro is a partner at Lauressa Advisory