Time for the next recession?
9 October 2018
As the business cycle expansion continues, increasingly this question is being raised. Anthony Rayner, manager of Miton’s multi-asset fund range, takes a view
This is the second longest US business cycle expansion according to the National Bureau of Economic Research, whose data go back to the 1850s. If there is no contraction before July 2019, it will be the longest since records began.
As a result, many investors are asking whether we’re due a recession. But time in itself is not an argument. Indeed, the evidence shows business cycles are getting longer, with the longest ever expansion only finishing in 2001.
A more interesting question perhaps, is why it’s the second longest expansion on record? Economic recovery wasn’t as rapid as in a more traditional recovery, wages and inflation have threatened less and so interest rates have risen more slowly. It feels like the cycle has been squeezed, perhaps due to high levels of debt and perhaps one of the many unintended consequences of the very experimental monetary policy of recent times.
Another question worth considering is what will likely lead to a contraction. It’s worth noting that economic momentum is strong and corporates are generally in decent shape, so it feels like it needs to be something material to knock the economy off course in the shorter term.
This would normally be a rise in rates, often driven by inflation, leading to a demand shock to the economy, or a more random event like an asset bubble bursting. That said, the precise causes of previous recessions are sometimes the subject of much debate amongst economic historians, with it often being a combination of factors.
Rates are rising in the US, and the Federal Reserve have set a course for gradual but regular hikes, unless something material changes. They are very aware of the risks of raising rates too quickly and, whilst wage growth is rising in a sustained manner, it isn’t cause for alarm yet. However, loose fiscal policy this year and next will only add to inflationary pressures. Again, not helpful in terms of timing, but at some point the Fed will be faced with a more difficult environment: the first time in a long time that they 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.
In short, cycles don’t die of old age and, whilst we might be able to hazard some broad guesses at the ‘what’, the ‘when’ is, we think, nigh on impossible to predict. The endless journey to find ‘where we are in the cycle’ is sometimes akin to looking for the pot of gold at the end of the rainbow.
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 more than 20%). In fact, using the MSCI World Index as a measure, there has been one 20+% correction and one near 20% correction during this expansion.
So, instead of spending time looking into crystal balls, we focus on the current data environment and try to ensure we have a portfolio constructed in as robust a manner as possible, to perform across a range of the most likely scenarios.
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