State of play - is a recession likely?
This time last year we were enjoying a positive background for markets with synchronised global growth and a surge in profit expectations. Today the mood is very different. Growth has slowed, markets ended 2018 on a sour note and fears of recession are widespread. The data have certainly been soft. Global industrial production, a key driver of the economic cycle, has stalled. Does this imply a looming recession? We think not. Global PMIs suggest a pick up and a series of distortions such as inventories being built ahead of Trump’s tariffs (later postponed) need to be considered. On balance, we expect a return to modest growth in the Spring.
A slowdown in growth
Key PMIs remain in expansionary territory, but there has been a marked deterioration in China and Europe.
Past performance should not be seen as an indication of future performance.
Source: BMO Global Asset Management. Bloomberg as at 15 January 2018. PMI- Purchasing Managers Index. YTD- Year to Date.
Inflation is major reason for believing worries over recession are overdone. We are still in a benign inflationary environment. The spectre of deflation has receded and for many countries inflation remains under 2%, which in turn limits the extent to which central banks need to hike rates.
Global inflation is not too hot, not too cold
Source: Minack Advisors as at December 2018. OECD – Organisation for Economic Co-operation and Development.
It is important, however, to acknowledge that risks have risen. Slowing growth, tensions around trade, populism and Brexit are all providing headwinds and uncertainty, triggering the moves we have seen in risk asset prices of late. These themes look set to persist, but with investors in a heightened state of nervousness, any surprise on the upside can have a big positive impact.
The US in focus
The outperformance of the US economy and its stock market has been a standout theme in recent years. However, with profits high and the labour market tight, many are beginning to question whether this can continue. The cost of labour is integral to assessing the prospects from here as it is a key determinant of both profits and the Federal Reserve’s decision-making process. When assessing the evidence, wages are rising (unsurprising given low unemployment levels) but the level of appreciation remains relatively gentle. Of course, the data needs to be constantly monitored and the Fed’s favoured measure, the Employment Cost Index, a quarterly series released later this month, should be examined closely.
Despite recent setback, the US has outperformed
Perspectives on the yield curve
The yield curve, the difference between long and short-dated yields on government bonds is usually positive. With the US yield curve flattening, the prospect of an inversion – which in turn has been a reliable indicator of recession – has increased. A focus on some of the detail here, however, means we are not unduly concerned. The role of banks and their willingness/ability to lend is an important consideration. In a typical recessionary environment, margin compression results in banks cutting back lending. Currently, however, margins have been increasing which with banks being well capitalised, provides a significant positive going forward.
The investment environment also provides reassurance. Rather than being in a typical cycle characterised by overinvestment, squeezed margins and subsequent retrenchment in hiring and investment activity, we stand at a juncture in which investment levels remain relatively low. This supports our view that the cycle still has some way to run.