Dave Lafferty
Dave Lafferty, Chief Market Strategist at Natixis Investment Managers examines why a “recession is imminent”…
A Recession is Coming
Economic forecasting is a tough business, not to mention incredibly imprecise. However, we can say with nearly 100% certainty that a US (and/or global) recession is coming – at some point. For investors, of course, the timing is all- important. Given current valuations and strong growth expectations, it is highly unlikely that equities could bear an economic downturn unscathed. This month we consider the path for the economy, coming headwinds to growth, and the possible timing of the next recession.
As Good as It Gets?
There is little doubt that the global economy has been strengthening in the last two years. As we’ve noted several times, most countries and regions saw a significant improvement in GDP starting in mid-2016 versus their previous 2010–2015 run rates. In many cases, this was corroborated by the strongest post-GFC economic levels, as measured by metrics like the ISM or PMI composites.
This strength was also exhibited by global equities. From mid- 2016 to the peak in late January this year, the S&P 500® rose nearly 37% in price terms alone (excluding dividends and reinvestment). Non-US stocks were up nearly as much, with the MSCI World Ex US gaining 36% during that period in local currency terms. The global economy was humming along and equity gains reflected it. But it’s during exuberant times like this that investors should begin to consider what the downside might look like.
Global Headwinds
While we expect global economic momentum to carry through 2018, we see growing headwinds affecting the global growth story starting in 2019, specifically:
- Higher short-term interest rates from the Fed, ECB, and BOE. Why is this different? Because until now, Fed rate hikes only generated real rates that were less negative. But as the fed funds rate breaches 2%, near the level of core inflation, real rates will actually move into positive territory. Simply put, until now, money has been more- than-free. That is set to end in 2019 as real rates turn positive.
- A yield curve that may continue to flatten/invert putting pressure on banks. The risk is that lending becomes less profitable, constricting credit expansion, which is the lifeblood of economic growth.
- Significantly more restrictive trade policy as countries retaliate and global supply chains are interrupted.
- US fiscal stimulus fades as tax-cut benefits wane. While some positive secondary effects will remain, without a kickstart to productivity, the tax cut’s impact will dwindle in 2019–20.
- Moreover, we see much less fiscal latitude in the face of massive budget deficits, particularly if the Democrats retake the House of Representatives in November.
- A very messy Brexit. The UK’s bumbling withdrawal from the EU is likely to trigger more uncertainty for businesses and consumers that will further stunt growth.
- Slowing credit growth in China will likely limit capital investment in the world’s most dynamic economy.
- Risk of higher oil prices. While we see the global oil market as roughly in balance near $60–$65/barrel on WTI, geopolitical risks in the Mideast are likely to ramp up, pushing oil prices higher – historically not a good sign for global growth.
To be clear, none of these dynamics are new, but each appears to be approaching a more painful inflection point. These headwinds have many market watchers forecasting the beginning of a global recession late in 2019 or in 2020.