We believe that the fear of impending recession is overblown.

Our Top Market Takeaways for the week ending September 20, 2019.

In case you missed it

Amid the usual hodge-podge of political drama, economic data and corporate news, we think there are three key things investors need to know heading into the weekend:

  • I wanted to make a joke about oil, but it was too crude. Last weekend, a series of coordinated drone strikes hit two of Saudi Arabia’s major oil processing facilities. The attack disrupted half of Saudi Arabia’s crude output (estimated at 5.7 million barrels per day, or 5% of total global production), and some evaluations suggest it was one of the biggest oil supply shocks since the Iranian revolution in the late 1970s. In the day following the event, the price of both Brent (the kind of oil that Saudi Arabia produces) and WTI (the kind that the United States produces) closed over +10% higher. Since then, Saudi Arabia has tried to reassure the market that its oil output will return to normal levels by the end of the month, and the price of oil has started to come down, with Brent closing around $64.50 per barrel and WTI closing around $58.10 per barrel on Thursday. Although it’s unclear whether or not these efforts will succeed, investors seemed to take this as a jarring reminder that the price of oil should incorporate a larger geopolitical risk premium than it has as of late.
  • (Overnight) interest rate markets got interesting. The repurchase (or, “repo”) market isn’t one that we talk about often because it’s usually very boring, and that’s a good thing. Think of it as the pipes through which the American financial system flows. Repurchase agreements allow party A to sell an asset to party B for cash, and party A promises to buy that asset back at a specified time and price in the future. Banks use such agreements, often overnight, to get the liquidity necessary to fund their day-to-day operations. This week, the cost of these agreements (i.e., the overnight lending rate) spiked dramatically—usually, the rate approximates the fed funds rate (which is now targeted to be in the range of 1.75%–2.00%), but this week it moved as high as 9%. Yikes, right?

    Well, yeah, because usually such dysfunction is associated with severe financial stress and illiquidity like we saw on the brink of the global financial crisis. But resist the urge to compare this week to past bouts of illiquidity—prior episodes like this were driven by credit concerns. This time around, the illiquidity has been driven by a lack of cash available to fund good-quality instruments. Said another way, we think this happened as a result of a perfect storm of various timing and technical dynamics, and we feel confident that the Fed has the right tools to fix it. Per his press conference on Wednesday, we know that Fed Chairman Powell isn’t terribly concerned, either.  
  • Easy does it. Speaking of the Fed, the FOMC announced its second 25 basis points interest rate cut of 2019 at the conclusion of its September policy meeting on Wednesday (no surprises there). That brings the target policy range to 1.75%–2.00%. While the domestic economy continues to stand on the shoulders of a healthy U.S. consumer, the easing measure was delivered in an effort to counter weakening global growth, tepid inflation and uncertainty surrounding trade policy. Going forward, it’s tough to say whether the Fed’s next move will be to cut, hike or keep rates steady. The Fed dot plot, which shows where each committee member thinks policy rates will be at a given point in the future, is showing more divergence of opinions than usual: By the end of this year, seven individuals see one more cut, five think policy rates should hold steady where they are, and five predict a rate hike. As for us? We think we could see one more cut in the next 12 months, if not by year-end.

While these three events each brought their fair share of agita, excitement, or both, none derail our core views on the economy and markets. We’re cognizant of the various risks in the investment backdrop, and will continue to closely monitor developments such as the above, but we don’t think a recession is imminent. Read on for why.

Is the recession obsession justified?

Something strange happened toward the end of the summer—the word “recession” re-entered the mainstream. If you just read the headlines, you might have thought we were in a recession already. According to Google, the word “recession” has only been searched more during the global financial crisis. This re-emergence is not without an explanation: Markets and economic data are showing some troubling signs. 

Line chart shows trends in Google searches for the words “recession” and “yield curve” from 2004 to 2019. According to Google, the word “recession” has only been searched more during the global financial crisis in 2008–2009, and the word “yield curve” is at its peak search frequency.

The most acute cause for concern is that the spread between 10-year Treasury yields and 2-year Treasury yields temporarily inverted in August. Historically, an inversion of the yield curve has been a reliable indicator that a recession was coming soon. 

It’s not just bond markets. The Federal Reserve retreated from its rate hiking campaign by lowering interest rates at the end of July. Globally, manufacturing and trade data is suggesting very weak levels of activity, and the tit-for-tat escalation of the trade dispute between the United States and China is damaging sentiment and adding to uncertainty.

Line chart compares Cyclicals vs. Defensives and the 10-year U.S. Treasury yield from August 2014 through August 2019. From October 2016 through August 2018, both lines trend upward (a period of cyclical leadership and high yields), but then decline back to levels they were at between February 2015 and September 2016.

While we aren’t dismissing these facts, we believe that the fear of impending recession is overblown. We think a better characterization of the current environment is a bumpy return to an equilibrium that existed in 2015 and 2016. What characterized this equilibrium? The environment wasn’t “recessionary,” as job creation continued and the global consumer was resilient, but it didn’t feel great for investors either. Manufacturing Purchasing Manager Indices suggested flat growth at best, global trade was stagnant, falling inflation was the norm and global bond yields were low everywhere. Equity markets trended sideways, and repeated disruptive headlines caused bouts of volatility. Eventually, global manufacturing and trade rebounded, yields rose, and cyclically levered equities outperformed their defensive counterparts. However, it did take two powerful jolts of stimulus to make it happen—the first was a massive housing and infrastructure build from China, and the second was enthusiasm after President Trump’s election.

This time around, there is good news and bad news for investors. The bad news first—we don’t think any similar jolts are likely in the near term. The good news—we also don’t think we are heading for recession.

Given our outlook, we expect more modest returns from assets, and that makes developing and implementing a disciplined, goals-based approach to investing all the more important.

To learn more about how we see the macroeconomic backdrop, and how we think investors should be positioned, see our full piece here.

Choose your own adventure

We live in an ever-changing world, and that raises questions about what it can mean for markets. We invite you to take a digital tour of our top ideas. Our experts discuss key concerns, from central bank policy to trade wars, with the ultimate goal of helping you make the best investment decisions to get you to where you want to go. Click here to explore our 2019 Investment Insights.

All market and economic data as of September 2019 and sourced from Bloomberg and FactSet unless otherwise stated.

We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.


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