- Market strategists and economists are advising clients on how to invest at a late stage in the economic cycle as recession concerns loom.
- Bank of America Merrill Lynch’s latest survey of global credit investors showed worries about a global recession have the strongest consensus for any concern in nearly two years.
- A Société Générale market strategist said in a colourful report this week that investors ought to “beware the economic cycle,” likening US investors to “stoned” pedestrians stepping into traffic.
The conversation around global economic growth has morphed into not if, but when, a severe downturn will take hold.
From the US and Latin America to the eurozone and Asia, strategists, economists, and money managers are trying to square the shift from healthy to disappointing global growth – and advise clients on how to position at a late stage in the business cycle.
Market strategist Albert Edwards of Société Générale told clients this week investors in the US are emerging from an era of historically low interest rates that’s rendered them unprepared for higher borrowing costs: “Stoned on free money, investors need to beware the economic cycle.”
Edwards invoked an oft-used parallel between central banks’ lax monetary policy acting as a drug of sorts for investors. He said every major central bank has “done its bit to inject another dose of euphoria into its market patch,” with the Federal Reserve’s recent about-face – which saw it shift from a relatively aggressive monetary policy to a more “patient” approach – leading the way.
The S&P 500 has staged a 19% rally off the December lows, and is now 5% away from recapturing its all-time high.
“Where investors could easily be caught out is in dismissing recent weak US economic data as due to one-off factors such as the very cold weather or the government shutdown,” he wrote. “Investors need to be doubly cautious at this late stage of the cycle.”
The strategist’s warning underscores a dominant theme coming from Wall Street in recent weeks as central banks around the world edge away from monetary-policy tightening, geopolitical uncertainty and recession concerns loom, and growth has either softened, slumped, or stalled almost everywhere.
At the same time, corporate America just booked the most disappointing earnings season in seven years, the impact of fiscal stimulus borne from the Trump administration’s tax reform package has all but faded, and US-China trade relations remain rocky.
Just consider insight from the BlackRock Investment Institute – part of the world’s largest asset manager – which set the stage in January when it told investors the “key question” right now was how long the current late-cycle phase might last.
“This year’s macro story is more about a synchronised global slowdown – with growth rates converging towards long-term trend levels – than actual recession risks, in our view,” wrote the report’s authors, led by BlackRock Vice Chairman Philipp Hildebrand.
Meanwhile, economists at HSBC echoed BlackRock’s sentiment in a comprehensive macro-focused report out this week that highlighted just how quickly investor sentiment has shifted.
“This time two years ago the commonly-used description for the global economy was ‘synchronised expansion’: all of the world’s major regions not only expanding, but accelerating, simultaneously,” HSBC economists Janet Henry and James Pomeroytold clients.
“How quickly the narrative has switched to one of ‘synchronised sinking’ with growing concerns about the global slowdown and outright fears among many that the Eurozone, not just Italy, may be on the verge of recession.”
As far as where people ought to park their money, Deutsche Bank equity strategists have come up with a basket for investments best-fit for the current environment: “late cycle,” as opposed to “end cycle,” by the firm’s classifications.
That means “prudent, quality companies cheap on cash flow,” a team of strategists led by Binky Chadha wrote. “In the late cycle phase, growth is still strong but cost pressures and risks are rising.”
They added: “In addition, with investors starting to worry about a potential end to the cycle, there is a premium for prudence, and companies with low leverage and low debt growth outperform, as do momentum stocks.”
Here’s a deeper look at how experts are classifying the current late-cycle condition and what they see:
“A big end-of-cycle fear”
Bank of America’s latest survey of global credit investors, released this week, found 30% of respondents said their biggest worry is a global recession, the strongest consensus for any concern in nearly two years.
The bank attributed this to a “torrid end to 2018 for the corporate bond market,” and said investors are retreating into more safe-haven groups and out of cyclicals.
This positioning appears unlikely to change until the global-manufacturing picture stabilizes, Bank of America said.
The “global industrial downturn”
Economists at HSBC used these two charts to illustrate the “global industrial downturn.” Even as GDP estimates for the US and China – the two largest economies in the world – have held steady, areas like Europe and Latin America have declined.
Industrial output has slowed in most countries, HSBC said, with European industrial data notably weak.
Evaluating recession odds
Even as growth in the US decelerates, it’s still above-trend, a team of strategists and economists at Deutsche Bank said in a report last week.
The firm referred to a broad indicator incorporating measures like lending standards, jobless claims, and surveys that have managed to hold up rather than dip into recessionary levels. Meanwhile, the likelihood of a recession in the EU is still relatively unlikely.
Data in the US
Although US economic data has remained stable relative to some developed market peers, there are glaring soft spots.
In a note distributed to clients Thursday, Joseph LaVorgna, chief economist for the Americas at Natixis, said the latest durable goods data “point to an economy that has rapidly lost steam.”
He says the data is quite highly correlated to the business outlook survey conducted by the Federal Reserve Bank of Philadelphia – another withering key manufacturing data point.
US becoming a “drag rather than a driver”
“We see global growth slowing as the expansion enters its final stage,” the BlackRock Investment Institute told clients in its January macro perspectives report. The slowdown comes as the US becomes a “drag rather than a driver” of growth.
The chart above shows the economy’s output gap – the difference between what an economy is producing and what it actually has the capacity to produce – next to the stages of US business cycles back to 1965.
An “irreversible path to an economic downturn”
Naka Matsuzawa, the chief Japan rates strategist at Nomura, said in a report out during the final days of 2018 that the “global economy is already on an irreversible path to an economic downturn.”
Still, his short-term outlook is less dire. He expects the global economy to recover, temporarily, in the second half of this year and into early 2020.
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