Investors are on recession watch
The writer is editor-in-chief of Money Week
Are we almost there yet? Global markets are more than 20 percent off their highs. And the past month has been particularly horrific.
Even the long-standing defensive (and supposedly diverse) strategy of having 60 percent of your wealth in stocks and 40 percent in bonds has been a disaster – 60/40 is heading for the worst year since 2008 (when a standard 60/ 40 portfolio fell by 20 percent). The only hiding place was China.
Unfortunately, this level of misery does not mean that more misery will not come. A recession may be on the way.
Bear markets do not necessarily cause or result in recessions. The short, but annoying, bear markets of 1962, 1966, 1987 and 2018, for example, didn’t. However, a recession can make a bear market significantly worse — or at least last longer.
Look at all the bears in the US since 1902 and you’ll see that those without a recession have only lasted 7.6 months on average. Those in recession have lasted an average of 23.8 months — and that’s with the generous inclusion of the super-short (one-month) bear market and the state-enforced recession of 2020.
This is of course logical. Bear markets are generally reactions to overvaluation – a return to some sort of average. In the absence of a recession—and thus no real change in the earnings portion of the equation—a drop in price back to a level where price-to-earnings ratios look good can be quick and easy.
But add recession and all simplicity collapses. We can set prices if we have one moving part, but not if we have two. If you’ve been wondering why all market analysts are now obsessed with the possibility of a recession and how long it could last, here’s the reason.
Finding the answer is a matter of first determining where inflation will go, and second, how central bankers will react to where inflation has gone. Most analysts look to commodity prices — the supply crisis that fueled this year’s horrendous consumer price indices — for the answers.
There may be a glimmer of good news here. The price of oil has fallen slightly and the price of copper (one of the most watched figures on the market) has just hit a 16-month low (down 14 percent so far this year). Mining stocks are also falling.
This suggests the tantalizing possibility that we are near peak inflation. If so, then maybe it won’t be long before central banks can pull back from raising interest rates, today’s terrifying anti-Goldilocks environment (everything is either too hot or too cold) and everything will evaporate. get well again.
If the central banks strike the right balance – improbable, I admit – we could eventually see exactly what everyone wants: a soft landing accompanied by either a few quarters of no growth or a very mild recession. Job done.
However, there is an inflationary wildcard here: wages. Listen to the news every now and then and you might conclude that real wages are collapsing everywhere. But that’s not quite right.
As market historian Russell Napier points out, wages in the UK were 13.9 percent above pre-Covid levels by the end of April 2022. Consumer price inflation had risen only 9.2 percent.
In recent months, inflation has reached new and annoying highs. But there is good reason to believe that wages will soon catch up. The UK labor market remains very tight (as is the case in the US, where real wages have also been rising since the start of the pandemic). And while union membership in the UK has halved since its peak in 1979, it’s rising again.
A summer of industrial action is already underway in the UK, as anyone hoping for an easy train ride to the first Glastonbury music festival in three years will know. And anyone planning a summer holiday will be increasingly concerned as British Airways employees just voted to strike.
There is, says Napier, “a rising market in the price of labour.” That doesn’t necessarily have to be bad news. In fact, you could see it as a welcome development. It makes a long, deep recession less likely.
Note that even in the grim consumer confidence figures released this week in the UK, buying intentions remained unchanged. And since central banks, especially the US Federal Reserve, seem to be more focused on Main Street’s well-being than Wall Street’s right now, the reward may be an inflation factor that worries them less than others.
Where wage growth can hurt, however, is profit margins. Look at companies’ earnings forecasts and you’ll see that not much misery is priced in.
Current estimates say UK companies will report earnings per share of 4 per cent above 2019 levels this year and US and European companies will see their earnings per share rise 38 per cent and 24 per cent respectively, notes Simon French of Panmure Gordon .
A summer of strikes and real wage increases could turn that around pretty quickly, recession or no recession. We may be almost there. It’s just that our destination may not be the one we expected.