BIG QUESTION: Whether we see an economic slowdown or recession is the key question for the $25 trillion US economy and global markets. A slowdown would leave corporate profits intact and set the scene for a market recovery this year, with valuations already adjusted. Recession would break the resilient profits anchor, drive another market leg down, and delay a rebound. This tug-of-war is driving volatility. Recession buffers are big but not unsurmountable, fears premature, and markets sensitive to ‘less bad’ news. Be invested, for a coming upturn, but defensive, to manage high risks. Own commodities, traditional defensives, and select big-tech.
BUFFERS: Recession buffers are large. We are slowing from strong growth. Consumers have excess savings and plentiful jobs. Companies strong profits and margins. Global PMI’s remain expansionary; US GDP NowCast accelerating from Q1, and yield curve indicators benign (see chart). Demand shifting from goods to services, not collapsing. ‘Peak’ interest rate and inflation expectations easing. Valuations fallen to 10-yr averages (but the last two troughs nearer 13x P/E).
WHAT IF: But these buffers are not impregnable, with the growth shocks seemingly relentless. Energy could spike further. China’s lockdowns endure. Covid could return. US inflation is only maybe peaking, and central banks could stay on front foot or make a policy mistake. Whilst company earnings is a big shoe that could drop, with all of the sell-off this year valuation driven. Earnings would fall c20% in an average recession, driving a painful second market leg down.
All data, figures & charts are valid as of 26/05/2022