Economic Data Improving in Europe and the UK – Potential Outperformance of Equities.

• The economic consensus now considers that the risk of recession is increasing in the United States and decreasing in the United Kingdom and the euro zone. This is a significant change from the start of the year.
• The problems faced by US regional banks do not appear to be leading to a credit crunch, but a crunch appears to be underway.
• A US recession would be bad news for US equities, but we believe the pullback will be modest. European and UK equities could outperform in relative terms.

The economic consensus now considers that the risk of recession is increasing in the United States and that it is decreasing in the United Kingdom and the euro zone. This is a significant change from earlier in the year, when the likelihood of a recession over the next 12 months was assessed at 90% in the UK, 80% in Europe and 60% in the USA.

Last week, initial claims for unemployment benefits in the United States jumped dramatically, and in the past such a development has been followed by a recession. But it seems that this development is due to fraud in Massachusetts and Deutsche Bank research suggests that the upward trend in requests since the start of the year disappears if these fraudulent requests are taken into account.

Moreover, the fears of many – myself included – that the problems at US regional banks could lead to a credit crunch were contradicted by other data last week. The Fed’s survey of loan officers and the survey of small businesses showed no decline in credit availability. It is even the opposite that has happened.

So are economists wrong about the risk of recession in the United States?

Not in my opinion, and I’m sticking with the forecast of a US recession by the end of the year. A credit crunch may have been averted, but a tightening is still underway. Credit is still available, but the terms are much more onerous and rate hikes have an impact. Borrowers reduce their demand for credit and consumers run out of steam. Last year they dipped heavily into their Covid piggy bank, but it looks like that support has stopped. We will have more information on the outlook for consumer spending this week with retail sales figures and earnings reports from Walmart and Home Depot.

If the US goes into recession by the end of the year, will the UK and Europe follow?

I think the economic data will continue to improve in Europe and the UK through to the end of the year. Consumer confidence is improving in both cases with lower energy prices, which could translate into higher spending. It is likely that these trends will reproduce themselves in companies.

What does all this mean for financial markets?

The US recession is likely to mean a decline in US equities, and given the prevailing bearish mood among analysts and investors, any decline should be modest. But equities are expected to perform worse in the US than in Europe and the UK. Second, US interest rates are expected to decline by the end of the year, even if they rise further initially. This means that last week’s dollar rebound should be temporary. Finally, after a few ups and downs, US bonds should recover.