SustainAbility: What if we have no more recessions?

There are many topics which are over-discussed in the investment industry, but recessions perhaps beat them all. Since I started my investing career in 1999 there have been three recessions in the US:

• March 2001 to November 2001 – this occurred in the wake of the technology bust of the late 1990s.
• December 2007 to June 2009 – the cause of this recession was the financial crisis and subprime mortgage lending. Falling home prices caused a credit crunch in the banking system, which led to falling economic activity.
• February 2020 to April 2020 – the severe economic effects of the Covid pandemic, as large parts of the global economy were shut down, led to a rapid decline in economic activity.

For those who prefer a longer-term perspective, there have been 48 recessions since 1776 when the United States was formed. This equates to a recession every 5.2 years. Taking the period since 1929, when the great depression occurred and modern central bank management of the economy began, there have been 15 recessions at a rate of one every 6.3 years, which implies some level of improvement in economic cycle management. Since 2001 we’ve had recessions at the rate of one every 7.3 years.

But then is it right to count Covid as a recession? The US economy was shut down by its government rather than being impaired by mismanagement of the economic cycle. Take that out and we’ve had two recessions in 23 years, or one every 11.5 years.

The point here is recessions are on average becoming less frequent, and arguably much less frequent, but commentary around the potential for a recession, stoked by an increasingly short-term and negative media, is increasing. It’s a mismatch investors would be advised to note.

As a thought experiment, how would it change your view as an investor if there were no more recessions? What would you do if that was the case? Which asset classes would you own, and which companies within them? The big winner would be equities, which thrive off economic growth and innovation. The big losers would be cash and debt, which beyond offering a level of stability and income (not to be dismissed as helpful for many investors) would not benefit from this scenario.

My point is not to say there will be no more recessions. Events will occur, like Covid, which will create dislocations in the global economy that result in a fall in economic activity. However, aside from this event risk though, recessions are becoming less frequent as the management of the economy learns from previous mistakes. Planning a portfolio based on no recessions is perhaps too optimistic, but arguably no more incorrect than planning for regular ones.

Market breadth…is broadening

One of the most common pushbacks to a more positive view on equity markets is one of breadth. It is well documented the strength of the so called ‘magnificent seven’ which includes Apple, Microsoft and Nvidia. These, and the others in the so-called seven, are indeed beneficiaries of many of the big trends we see around us, such as artificial intelligence. It would be a mistake however to think they have been the only drivers of global markets.

In Japan, India and Europe, stock markets are making all-time highs. These countries do not benefit from the magnificent seven. In the US, in February and March the industrial, financial and materials sectors outperformed technology. These are important signs of breadth which are perhaps under appreciated.

In my experience, bull markets tend to start narrow and broaden out as they mature. The argument is always made early on that narrowness is a sign that the rally is not well underpinned. There is some logic to this, but what happens if the broadening starts to occur?

We have seen some notable weakness in several of the technology names which previously have led markets higher underperform, including Tesla and Apple. And yet markets have continued to move higher as other areas have taken up the slack. I think this is a positive signal.

US economic growth

Perhaps the greatest surprise of 2023 was the strength of the US economy. Could it be about to pull the same trick again this year?

In real terms, the US economy grew at around 3% in 2023. In nominal terms, accounting for inflation, growth was likely above 7%. Companies live off nominal growth, so it is no surprise their profits were strong last year.

This is starkly different from the consensus view which was one of recession. The now infamous Bloomberg view in October 2022, of there being a 100% chance of a recession in 2023 based on their models will live long in the memory as one of the great contrarian signals of our time. Since then, the S&P 500 is up 46.6%!

The best, real time estimates, of the US economy are that it grew at a rate just above 2% in real terms in the first quarter of 2024, and around mid-single digits in nominal terms. It would seem the momentum of last year has continued. Why is this? Ed Yardeni, a US-based economist, provides a useful framework for thinking about it. Here are some of his key points.

To understand the US economy is to understand the US consumer. Consumer spending currently accounts for 67.7% of nominal GDP. Real consumer expenditure grew at around 2.7% in Q4 2023. What is driving this is, in Ed’s words, that Americans have never been better off. With high levels of employment, and record levels of stock markets and home prices it is easy to see why.

This strong consumer is then complemented by strength in capital expenditure, for electrification and data centre growth, and government expenditure which rose to a record high as can be evidenced by large budget deficits. No wonder the US economy is strong!

The question is what could change this rosy situation? Much like a view on the possibility of a recession it is more likely to be an event than the economic cycle. Events which are talked about include a blockade of Taiwan by China, a dislocation in debt markets due to the high level of government spend, and maybe changes in political leadership around the world.

In reality, no one knows what the future holds and that is perhaps the key lesson of the last few years. We do think though a positive bias in considering potential outcomes has historically, and objectively, led to better investment outcomes. This is our bias now, and we believe that the US economy could once again surprise to the upside this year.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.