Regular readers of the CIO Weekly Perspectives know that we try to relate our observations on topical news to our medium-term investment outlook. Yet a “weekly” commentary inevitably gets a little caught up in current headlines.
So this week we try to dig beneath the surface of the headlines that are dominating current markets. There are already plenty of deeper indicators of what the world might look like in 2017-18.
An uncertain fall ahead
For sure, there’s a lot to dig through between now and the end of the year: quarterly earnings, GDP growth, employment figures, and, of course, central bank policy decisions. After 20 weeks of corporate bond purchases, last Thursday Mario Draghi’s pronouncements left markets looking to December 8 for more hints about whether QE (quantitative easing) would be extended or “tapered”. Six days later we will have a Federal Reserve announcement likely to increase short-term rates. And, if you haven’t heard, the US has a big vote on November 8, Italy has a tricky referendum to get through on December 4 and Spain may be forced into yet another general election before the end of the year.
These events are likely to move markets — understandably. Some will undoubtedly feature in forthcoming CIO Perspectives. But, as investors become consumed with these current events, storm clouds seem to be gathering and recession risks rising.
Recession risks rising
Near term economic data looks decent enough. US GDP for the second half of the year will likely show an improvement on the first half and, while it’s early days in the Q3 earnings season, it looks like S&P 500 earnings, while nothing to write home about, will have modestly improved.
Nonetheless, that only brings us to flat earnings growth, year-on-year, and it marks six straight quarters of weak reports. Moreover, the Bureau of Economic Analysis’s National Economic Accounts reveals this to be a problem across US businesses, not just among the S&P 500 elite group of companies.
Housing starts have slowed, retail sales and consumer confidence are softening and employment growth seems to be peaking. The inflation we are experiencing is not benign: non-discretionary costs such as energy, housing and healthcare are rising, but not discretionary costs — a characteristic of recessions, historically. Wages are rising, which will put pressure on companies’ margins. And of greatest concern, credit conditions appear to be tightening: recent editions of the Federal Reserve Board’s Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) report tightening lending standards for all companies, but especially smaller firms.
We are late into an elongated cycle
These are all late-cycle indicators. We should not turn a blind eye to them just because GDP and earnings have ticked up slightly on a weak first half of the year.
Let’s be clear: I’m not calling for a recession to start on January 1, or for investors to sell all their risk assets. Indeed, this has been an elongated business cycle and there is a good chance that it can be elongated still further. Even casual observers of this economic cycle will conclude it has been quite unique. What might lead us to get more optimistic in our outlook? Political leadership doing their job: corporate tax reform, infrastructure investment, and a more sensible regulatory environment.
We have written a lot over recent weeks about the growing probability of extra fiscal stimulus around the world, for example. Central banks have been keeping things afloat for years and will continue to try to do so.
But it’s also true that central banks are conceding the limits of their influence and that politics can easily get in the way of fiscal plans and structural reforms. Even in the best-case scenario, no central bank or government has ever been able to legislate the business cycle out of existence.
So this is just a timely reminder that the cycle will turn at some point, and that a couple of quarters’ headlines can obscure late-cycle dynamics that are appearing in the data. Digging down to these underlying dynamics keeps us relatively cautious on risky assets.
Joseph V. Amato is President of Neuberger Berman Group LLC and Chief Investment Officer
