The risk of a US recession

The most important issue for investors is the risk of a US recession in 2016. It would, of course, play out to a global recession. There are cyclical, structural and secular forces at work in this recession risk call.

Filmed January 2015 (3 mins)

Edited transcript

At PortfolioConstruction Forum Conference in August 2014, I argued that volatility would return to markets. And, of course, we’ve seen that come about, with meaningful moves in equity markets over that timeframe.

Today, I think the most important issue for investors is the risk of a US recession in 2016. It would, of course, play out to a global recession. There are cyclical, structural and secular forces at work in this recession risk call.

On the cyclical side, there are two factors in particular that come into play.

Firstly, the US Federal Reserve is intent on raising interest rates in response to perceived inflation and therefore tightening up monetary policy as they have been doing as they've unwound QE over the last 12 months.

Secondly, adding to that, we have a risk of a profits recession in the US, brought about by wage inflation in an economy where the companies are not nearly as productive in this cycle as they've been in prior cycles. Unproductive companies struggle to absorb wage inflation and that struggle leads to a profits recession - and, at its heart every economic recession, is a corporate profits recession.

The cyclical factors at work are mingled with structural and, indeed, secular factors.

In particular, I would argue that since 1997 (you could argue since further back), the US economy has been very dependent on the wealth effect. Witness Bernanke's comments that the Fed is “doing QE to get the stock market up, to get the economy going.” It's what we term topsy-turvy economics - it's the wrong way round. It should be that an economy is performing well and the stock market reflects that, rather than the other way around!

So we have a financialised US economy, heavily dependent on a wealth effect, where middle income earners haven't really benefited at all in the recovery, in fact quite the reverse.  We have a very unstable growth performance that's very vulnerable to the removal of that cheap money, the reversal of the wealth effect, and the reversal of some of the financialisation dynamics including through the corporate sector with the issuance of debt and share buybacks.

These structural issues, cyclical issues and, indeed, secular issues are intermingled and create the risk for a potential recession in the US in 2016. This means mean investors could need to dramatically alter the way their portfolios are positioned over the course of 2015.

I look forward to joining you at PortfolioConstruction Forum Conference in August, and explaining this in more detail later on this year.
 

Chris Watling is CEO and Chief Market Strategist with Longview Economics. Longview Economics is an independent consultancy specialising in macroeconomic, thematic and commodity research. It offers strong macro and quantitative views across all major asset classes and markets. Chris is a regular speaker at PortfolioConstruction Forum Conference each August..