A Timeless Solution

In many ways, over the last couple of years, we have had a ‘war time’ response to the COVID-19 crisis, with very easy fiscal and monetary policy working in the same direction and unfortunately, overstimulating global economies.

We are now approaching the ‘cold turkey’ stage. This is not much different from the political business cycles we encountered in the 1980s before central banks became independent. Now, we are experiencing very strange, scary and short-lived economic cycles with large swings that we expect are yet to come.

We believe major economies are approaching one of the most significant macroeconomic turning points in recent decades; that economic growth and inflation have reached their peak (certainly in the US) and central banks are tightening financial conditions at a time when their economies are heading into a slowdown. We believe that markets are pivoting from a ‘headline inflation’ hysteria towards what we see as quite an acute ‘growth shock and economic downturn’.

Where are we today?

Back in autumn 2021, we mentioned that April 2022 was to be a key inflection point for growth momentum in the economies – that it would begin to collapse from a year-on-year perspective given the strength of economic data twelve months previously. The growth outlook is currently looking even worse than we expected as every region of the world is being downgraded (see chart). Further, according to the International Monetary Fund, GDP-weighted global growth is expected to be down 3.2% year-on-year in 2022 – a level normally seen in a recession.

2022 growth forecasts

Given hawkish central bank action, as inflation keeps surprising to the upside, the debate on whether there will be a soft or hard landing in the economies has now intensified.

We lean on the bearish side of the consensus in this debate. In part due to the self-induced financial tightening as a result of rising interest rates and quantitative tightening plans, but also because of ‘consumer confidence’ data. The latest figures show a drop across the globe to levels that are associated with recessions. They also reveal that consumer confidence has decoupled from the employment market, as sentiment has fallen – despite lower unemployment rates. This points to a dismal picture of household sentiment as the impact of inflation and higher energy prices put a drag on confidence at the individual level.

More corroborating evidence for our bearish stance

Tightening financial conditions are being felt everywhere and there are increasing numbers of indicators that point to a significant slowdown in growth. The strength of the US dollar, collapsing business confidence since March in the developed world, signs of banks tightening lending in the eurozone, and a downtrend in major Purchasing Managers’ Indices (PMIs), to name a few.

In the US, trucking data shows a sharp fall in demand since March, while there are similar drops in a few other consumer areas such as sales of used cars and mattresses, indicating a real shift in consumer sentiment. Housing activity is on a downward trend and in the retail sector, recent profits warning from some of the biggest retailers emphasise how many companies have over earned, over stocked and over hired on an unsustainable basis over the course of the pandemic.

Finally, the odds of a recession increase with rising oil and energy prices, which are akin to a tax on growth – while energy is a more significant factor in the Europe, US household spending on energy is also up to levels close to those seen in the oil shocks of the 1970s.

Where are we heading?

From a year on year perspective given the high base data in 2021, inflation figures should generally come down from here. The real questions are by how much, and will they remain at uncomfortable levels?

Central banks are on a mission to tame inflation, seemingly accepting the consequences of ‘demand destruction’. Given their aggressive stance plus all the other evidence, we believe that we are likely heading for a steep downturn and that a recession is unavoidable – a hard landing is almost certain in the UK and Europe with a less severe downturn expected in the US.

We have recently experienced an extraordinary boom bust cycle driven by COVID 19. In our opinion, economic cycles will likely be more boom bust going forward as the echo of COVID lingers (similar to the echo of Lehman post the Global Financial Crisis). While the next cycles might be shorter and/ or more violent, they are likely to also open up good opportunities for investors.

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