Investors must not only prepare their portfolios, but also position themselves to seize the investment opportunities that will drive the markets until 2024.
The public perceives periods of recession as periods of economic gloom. Investors generally associate this concept with drastic and lasting declines in asset prices. However, the American recession announced for mid-2024 will be very different from previous ones, in terms of form and feeling.
It will not only be shorter in duration, but also much smaller in scale. As a result, investors must not only prepare their portfolios for this recession, but also position themselves to seize the investment opportunities that will drive the markets through 2024.
Market Overview
Although the US Federal Reserve (Fed) has raised interest rates by 5.25% since February 2022, economic activity data remains strong, consumer demand remains strong and job growth begins just slowing down.
However, the current strength does not call into question the imminence of a recession. Monetary policy generally operates on a reaction time that is both long and fluctuating and, given the speed with which interest rates were raised, this policy has only been binding over a relatively short period, which suggests that the pressure on economic activity is only just beginning. With the Fed indicating that interest rates will remain high for a long time, it is expected that a tightening of monetary policy will worsen the already tight credit situation, thus weakening the health of the American economy.
American recessions over time
Since the Great Depression, the United States has experienced 14 recessions. On average, these lasted 14 months and led to a drop in economic production of 2.5%. Some recent recessions have been very severe: the great recession of 2008, following the GFC (Global Financial Crisis), lasted 18 months and resulted in a 4.3% drop in GDP, while the unemployment rate more than doubled to 10%. The S&P 500 index fell 56.8% between October 2007 and March 2009, and during the dot-com crash of the early 2000s, that same index lost nearly half its value.
Will the looming recession and the impact on financial markets be as severe?
U.S. real GDP relative to pre-GFC trend
In billions of seasonally adjusted chained 2012 dollars, 2003 to present
Source: Bureau of Economic Analysis, Bloomberg, Principal Asset Management. Data as of June 30, 2023.
The Fed raised interest rates in a manner similar to what was done in the run-up to the GFC. However, not all recessions result in lasting economic disasters like the GFC, although the tightening of monetary policy has been just as significant, if not more aggressive. The effectiveness of monetary policy and its impact on growth depend on the sensitivity of the economy to interest rates.
The GFC recession (and, similarly, the collapse of the dot-com bubble in 2001) was particularly severe due to the excessive debt accumulated in certain segments of the economy, which increased the sensitivity of the American economy at interest rates.
Today, the sensitivity of the American economy to interest rates is much more limited. Indeed, the unique circumstances resulting from the post-pandemic environment make the current economic environment very different from that which prevailed at the start of the internet collapse and the onset of the GFC recession.
Unlike at the start of the GFC recession, households and businesses are not as indebted today. Closures during the pandemic generated forced savings, while government and central bank support allowed businesses to access credit and households to increase their incomes. As a result, American businesses and households have approached this downturn with reduced debt and excess savings, thus promoting their resilience in the face of significant shocks.
Future prospects
The unique nature of post-pandemic fiscal support has likely lengthened the reaction time to monetary policy, thereby shielding the economy from interest rate increases over the past 18 months. Concerning the corporate sector, with a level of debt still low for the next two years, which continues to protect them against rising interest rates, the reaction times of monetary policy are particularly long.
On the other hand, the various household aid measures are coming to an end. The fiscal support linked to the pandemic is ending and, at the same time, a large part of the excess savings cushion has been exhausted, with only $0.23 trillion remaining, according to estimates. By the start of 2024, many households will be hit hard by rising interest rates.
Household spending should therefore start to weaken over the coming quarters, but the impact on economic activity will be partially offset by business spending, which will remain strong. This phenomenon should reduce the expected slowdown to a short-term, low-level recession episode, extending over two quarters, leading to only a 0.35% drop in economic production and only increasing the rate of unemployment only around 4%. In the eyes of investors, this should be seen as a moderate recession environment.
What are the implications for asset allocation?
Preparing portfolios for changing economic conditions, or even periods of economic recession, can be difficult. Especially since today, the perspectives are not necessarily homogeneous.
Our forecast for a short-term, mild recession supports a neutral stance on all assets. A short-term, low-level recession means the window for getting into stocks at attractive prices will be narrow and investors will need to avoid the trap of trying to time market troughs.
As markets struggle to take a clear direction and there is no prospect of a strong recovery or significant decline in the value of risk assets in the near term, it is unlikely that stocks, bonds or products alternatives outperform the market. Until more obvious signs of an economic slowdown emerge – which we do not expect until late 2023 or early 2024 – markets are expected to remain range-bound, which argues in favor of neutral positioning.
2023-09-29 05:00:00
#shortterm #lowlevel #recession #United #States
