Recession Jitters Intensify - But Most Don’t See it Until 2023

Experts polled recently for Bankrate’s First-Quarter Economic Indicator say there’s a 33 percent chance that the U.S. economy could contract in the next 12 to 18 months, with key downside risks surrounding the conflict in Ukraine, high inflation and tighter monetary policy.

“It would be bad news if the Fed is steering the economy straight toward recession-ville,” reported Axios, an American news website based in Arlington, Virginia. “But bond market indicators so far are more consistent with a slowdown in activity that helps rein in inflation without slipping into an outright economic contraction.”

The latest recession concerns stem from what’s known as the yield curve inversion, which occurred in late March, when 10-year yields rose above two-year yields—an event generally seen as a recession predictor, according to Axios.
“But if you believe that the Fed will be reactive to incipient recession risk, a yield curve inversion, especially a small one, is more consistent with the economy coming in for a soft landing than crashing into recession,” Axios noted.

yield curveAt a March 24 event, the "Outlook for Global Markets and Investment Strategies" panel of Quinnipiac University's 11th Global Asset Management Education (GAME) Forum was guardedly optimistic about avoiding a recession. But caveats and risks abound, including the possibility that the Federal Reserve Board will over-react and raise interest rates too high.

"It depends on how Ukraine plays out," said David Kelly, chief global strategist at J.P. Morgan Asset Management. He offered several scenarios, including an escalation that would force Europeans to abandon Russian energy.

"In that case, Europe is hurt worse than the U.S., but Europeans are pulling together now," Kelly said at the Quinnipiac event. "I see the U.S. well positioned as COVID fades, the economy opens up, and job demand remains high. But the longer inflation stays around the stickier it gets."

As far as impact of the war Russia is waging in Ukraine, Russell Investments’ Global Market Outlook, released March 29, sees the 2022 economic outlook being “dented but not derailed,” and its team of strategists still sees the global economy on track for moderately above-trend growth.

“Sentiment for equity markets is firmly oversold but not yet at the level of panic reached in late 2018 and early 2020,” Russell Investments said in its report.

“Markets had plenty to worry about before the invasion, including the onset of U.S. Federal Reserve (Fed) tightening, the impact of COVID-19 lockdowns on supply chains and inflation, as well as the outlook for China,” said Andrew Pease, global head of investment strategy at Russell Investments. “We expected global growth to moderate from the post-lockdown surge in 2021 but remain above trend in 2022. The consequences of the invasion are lower global growth, with Europe taking the largest hit, coupled with higher inflation.”

Russell Investments’ strategists believe the war is unlikely to reduce U.S. growth by more than half a percentage point, while the impact on European growth is likely to be 1.5-2 percentage points. This would take 2022 gross domestic product growth (GDP) projections to 3 percent for the U.S. and 2.5 percent for Europe.

“2022 still looks to be a year of above-trend growth as strong household and corporate balance sheets keep the economy on firm footing for now,” Pease said.

Putin invadesWhile the war in Ukraine has injected further uncertainty into the outlook, Russell Investments’ strategists believe the U.S. should be among the most resilient economies globally given its energy independence and lower share of commodity consumption in GDP.

More broadly, the team sees the business cycle as rapidly maturing, the labor market remaining tight and the Fed on a path to more restrictive monetary policy. They also see recession risks gradually increasing from the rock-bottom levels earlier in the recovery.

According to Russell Investments’ cycle, value and sentiment investment decision-making process, U.S. equities are seen as expensive, UK and emerging markets are at fair value and Europe is now only marginally expensive given recent market declines. The Japanese market also scores as slightly expensive. On balance, the team still expects the cycle to be supportive for global equities, while headwinds remain for government bonds.

“Sentiment for equity markets is firmly oversold but not yet at the level of panic reached in late 2018 and early 2020,” Pease said.

As far as credit markets, Russell Investments is taking a neutral stance, acknowledging that the high yield spread is still low by historical standards and investment grade credit spreads, which widened following the Russian invasion of Ukraine, are back to their longer-term averages.

“High yield spreads will be at risk if the Russia/Ukraine conflict escalates but could perform well if hostilities subside and the cycle outlook improves,” Pease said.

Government bond valuations are mixed after the recent selloff, with the U.S. now fairly valued and Japanese, German and UK bonds still expensive, according to Russell Investments. “Yields will face upward pressure from continuing inflation increases and central-bank hawkishness,” Pease said. “A positive for government bonds is that markets have fully priced potential tightening by most central banks, and this should limit the extent of any further selloff.”

Regarding real assets, the Russell Investments team expects both global listed infrastructure (GLI) and real-estate investment trusts (REITS) to benefit if Russia/Ukraine hostilities subside, the pandemic recovery resumes and inflation concerns continue.

The team notes that the best-performing asset class has been commodities with energy and agricultural prices surging on the Russia/Ukraine conflict. Russell Investments expects some of these gains will be reversed if hostilities subside, but strong global demand and supply bottlenecks should support prices. “On balance, the case for commodities exposure is still positive,” Pease said.

weak dollarThe U.S. dollar, which has made gains this year on Fed hawkishness and safe-haven appeal during the Russia/Ukraine conflict, according to Russell Investments, is expected to weaken if hostilities subside and lower inflation outcomes later in the year lead to less Fed tightening than markets currently expect.

Those worried about an imminent recession might find solace in S&P Dow Jones Indices reporting on April 4 that dividend net changes (increases less decreases) for U.S. domestic common stocks increased $18.2 billion during Q1 2022, compared to $18.0 billion in Q4 2021, and $18.0 billion in Q1 2021.

"We are seeing more companies increase the size and percentage of their increases and fewer reducing payments,” said Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. “With earnings and sales setting record highs and cash flows strong, we expect this trend to continue even as interest rates rise."

Silverblatt added: "While a consumer slowdown and a potential 2023 recession are major concerns, the shorter-term concern remains inflation, as higher payouts would need to compete with other rising rate instruments. In the end, however, dividend investors typically weigh the risk-reward components with a bias towards secure income."

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