When is the next recession coming?

Forget crystal-ball gazing, investors should focus on more than the US economic cycle and the timing of the next downturn.

This is the second-longest US business cycle expansion, according to the National Bureau of Economic Research – and its data goes back to the 1850s. If there is no contraction before July 2019, it will be the longest expansion since records began.

As a result, many investors are asking whether we are due a recession. But time in itself is not an argument. Indeed, the evidence shows that business cycles are getting longer, with the longest expansion to date finishing in 2001.

A more interesting question, perhaps, is why it is the second-longest expansion on record. Economic recovery wasn’t as rapid as in a more traditional recovery, wages and inflation have been threatened less and so interest rates have risen more slowly.

An experimental approach

It feels as though the cycle has been squeezed, perhaps owing to high levels of debt, and this is possibly one of the many unintended consequences of the experimental monetary policy of recent times.

Another question worth considering is what is likely to lead to a contraction. It is worth noting that economic momentum is strong and corporates are generally in decent shape, so it feels as though it needs to be something material to knock the economy off course in the short term.

It would normally be a rise in rates, often driven by inflation, leading to a demand shock to the economy, or a more random event such as an asset bubble bursting. That said, the precise causes of previous recessions are sometimes the subject of much debate among economic historians, with downturns often being attributed to a combination of factors.

Rates are rising in the US, and the Federal Reserve has set a course for gradual but regular hikes, unless something material changes. It is very aware of the risks of raising rates too quickly and, while wage growth is rising in a sustained manner, it isn’t yet cause for alarm.

However, loose fiscal policy this year and next will only add to inflationary pressures. At some point, the Fed will be faced with a more difficult environment, and it will be the first time in a long time that it will need to raise rates to control inflation.

Asset bubbles are notoriously difficult to time, with valuations proving largely unhelpful historically, as trends tend to go on much longer than valuations would suggest. Scanning the globe, there are areas of concern, for example, the Chinese property market and the multi-decade bull market in bonds, but there are always areas of concern.

Cycles dont die of old age

In short, cycles don’t die of old age and, while we may be able to hazard some broad guesses over when things will change and the causes, it is nigh on impossible to predict. The endless attempt to find where we are in the cycle is sometimes akin to looking for a pot of gold at the rainbow's end.

However, as investors, we shouldn’t just be focused on the US cycle or a recession. Let’s not forget that within an economic expansion there can be a bear market (defined as a drop of more than 20 per cent). In fact, using the MSCI World Index as a measure, there has been one 20+ per cent correction and one near 20 per cent correction during this expansion.

So, instead of spending time looking into crystal balls, we focus on the current data environment and try to ensure that we have a portfolio constructed in as robust a manner as possible, to perform across a range of the most likely scenarios.

Anthony Rayner is manager of Miton’s multi-asset fund range.

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