Is a recession coming and should investors care?

The US economy has been growing since mid-2009, making it one of the longest economic expansions on record, and investors aren’t expecting it to end anytime soon.

According to the latest Bank of America’s Merrill Lynch Global Fund Manager Survey, just 2 per cent of investors are expecting a recession in 2018, with most banking on growth continuing well into 2019.

Over 30 per cent expect a recession in the second of half of 2019 and over 25 per cent expect growth to end in the first half of 2020. 

According to Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, the belief among investors that the US won’t see a recession anytime soon is good news for markets.

‘Although cash levels remain high and growth optimism is at the lowest level in over two years, a majority of investors say there is room to grow in this equity bull market and don’t see signs of recession anytime soon. Fund managers think the May rally can extend in the near-term,’ he notes. 

Economists seem even more bullish. As the results of the survey below show, most are expecting the US’ economic expansion to continue through to the next decade, with over 50 per cent of those surveyed only expecting a recession to come about in 2020. 

However, some indicators suggest investors should be a bit more sceptical of longevity of the US’ economic expansion. 

One method of predicting a recession is to look at the US treasuries ‘yield curve’. Currently, according to Oxford Economics, the yield-curve model puts the odds of a recession at 10 per cent. This is the highest level seen since the 2008 financial crisis, albeit way below the 30 per cent reached in the run up to every other recession since the 1960s, as the chart below shows.

As the Wall Street Journal’s Daily Shot newsletter author Lev Borodovsky notes: ‘While the flattening Treasury curve is not yet forecasting a recession, some economists are becoming concerned about the trend.’

Employment rates also may be pointing towards an end of the economic expansion. Unemployment in the US hit a 17-year low in April, with just 3.9 per cent of the workforce out of the job. While that should be good news, it potentially means a recession is on the horizon. 

The question, however, is how much lower unemployment can go. While the US in the 1950s saw unemployment rates as low as 2.5 per cent, more recent unemployment troughs before a recession have been above 4 per cent, higher than the current rate. 

What would a recession mean for markets?

In a recession, customers buy less and businesses sell less. Profits contract and so do stock market prices. 

However, according to recent research from Richardson GMP, a wealth management firm, the pain felt by markets and investors often comes before a recession, not during. 

As the chart below shows, using the price performance of the US’ S&P 500 index since the 1940s, equities usually start to underperform a year before a recession takes hold, with the period six months before a recession seeing the biggest losses. 

So, when a recession does come, investors may have already felt the brunt. 

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