Who should be preparing for a recession?

Dec 05, 2019

Economic indicators suggest a global recession is unlikely. However, Charles Hepworth believes there is one country that might be moving closer to recession territory.

With Brexit looming and all its attendant uncertainty, a declining domestic GDP and large-scale layoffs which have contributed to the general public’s concern over the state of the British economy, the UK could be close to entering a technical recession.

A recession is traditionally defined as the economy contracting for at least two consecutive quarters. Considering a full business cycle is approximately 4.7 years and that the last global recession ended in 2009, it could be argued one is overdue. Fears in the UK have been further magnified by the fact domestic GDP growth was negative in the second quarter of 2019, making Q2 the first contraction since the fourth quarter of 2012. Based on the technical definition, the UK would have been one bad quarter away from a full-blown recession if Q3 didn't see GDP growth of 0.3%.

We can look to the floundering services industry as a key indicator of the current economic state. The sector makes up about 80% of the UK economy and, in August, it stalled uncharacteristically. Given the current political environment, it seems corporates are unwilling to make significant investment decisions given the lack of clarity around Brexit and the potential for restrictions on imports and exports. The overall uncertainty surrounding Brexit and the UK’s relationship with Europe has also contributed to falls in domestic construction and manufacturing sectors.

Globally, central banks are treading a fine line of avoiding investor panic, in my view. The US economy remains strong, even as key European economies are in contractionary phases. We have seen stimulus packages in the US and across Europe, as both the Federal Reserve and the European Central Bank utilise quantitative easing to aid their respective economies. In the case of the US, GDP growth has remained strong, up 2.1% in the second quarter of this year and 1.9% in Q3. The consumer price index, often used as a recession indicator, showed a 1.8% core increase in the 12 months through October. Based on these numbers, we do not anticipate the US will enter a recession any time in the near future and that while certain markets might arguably have recessionary attributes, a global recession is unlikely, as well.

Alongside the generally optimistic data, I feel investor sentiment is broadly positive outside of the UK. A resolution of the US-China trade war could provide some additional relief and rally the markets, particularly in regard to the US’s briefly inverted yield curve. Although, historically, an inverted yield curve has often served as the harbinger of a recession, this time around it is being somewhat contradicted by record high employment rates in the US and Europe (the UK included). Furthermore, an inverted yield curve tends to precede a recession by anywhere from 14 to 36 months, making an imminent economic fall unlikely.

The international climate is ambiguous, but I believe that the UK is the primary economy at immediate risk of entering a recession. The world’s largest economies (US, China and Japan) have remained strong so far but the UK, on the other hand, has the particular issue of the Brexit paralysis. Consumers have become more risk averse, while businesses are reluctant to invest heavily when surrounded by such ambiguity lack of clarity over the outcome.

Charles Hepworth is the Investment Director, Managed Portfolios at GAM.

This article was originally published in The FM Report.