Frances Donald, Global Chief Economist and Strategist, and Alex Grassino, Co-Head of Global Macro Strategy at Manulife Investment Management provide an in-depth analysis of the economic outlook, particularly focusing on the possibility of a recession in the United States. Here's the TL;DR overview:
- U.S. Economic Outlook: Donald predicts a mild to moderate recession in the U.S. within the next six months, characterized by two consecutive quarters of negative GDP growth and a rise in unemployment rates.
- Beyond Binary Recession Labels: Grassino and Donald argue that the binary framing of "recession or no recession" is less helpful for investors. Instead, they emphasize the importance of understanding the decline in growth momentum, which includes factors like lending, consumer activity, capital investment, and earnings.
- Sector-Specific Opportunities: Grassino emphasizes that despite a deteriorating broader economic environment, there could be opportunities in specific sectors. The U.S. manufacturing and services sectors are running on separate cycles, which might lead to a recovery in manufacturing even as the services sector weakens.
- Labor Hoarding and Unemployment: Donald discusses labor hoarding as a response to labor shortages, suggesting that this might lead to a less pronounced rise in unemployment rates compared to past recessions.
- Heightened Uncertainty: The current environment is marked by heightened geopolitical risk, supply-side-driven inflation, and more frequent severe weather events. These factors are expected to challenge and distort traditional understandings of recessions.
- Global Context: The U.S. economy, even in recession, might still be relatively strong compared to other regions. Donald and Grassino suggest that the U.S. could be the "cleanest dirty shirt" in a global context, with other regions like Europe, Canada, Australia, and emerging markets potentially facing more significant challenges.
- Investment Implications: Grassino and Donald propose a framework for investors to navigate this environment, focusing on momentum and sector-specific opportunities rather than the binary concept of recession.
by Frances Donald, Global Chief Economist and Strategist & Alex Grassino, Co-Head, Global Macro Strategy, Manulife Investment Management
The idea that a U.S. recession could be imminent is likely to spark anxiety among investors. We highlight five considerations that investors should pay attention to.
1 U.S. economic outlook
Hopes for a soft landing may be growing, but we continue to believe that the U.S. economy will slip into a mild to moderate recession within the next six months. Simply put, we expect to see two consecutive quarters of negative GDP growth, accompanied by a rise in the unemployment rate.
Instinct might suggest this classifies as out-and-out bad news for investors, but we think it’s worth questioning whether that’s necessarily true or does it have more to do with how we’re conditioned to viewing the economy through binary lenses: growth (good) versus recession (bad)? As long-term investors, we think this “recession or no recession?” framing is unhelpful at best and, at worst, can stand in the way of investment returns. Instead, a more thoughtful approach is needed.
In the coming months, we believe the consensus view in the market will revert back to a U.S. recession being a base case. Once that dreaded word comes back into play, investors should assess those newly downbeat forecasts through the lens of five core considerations that we believe hold more meaningful investment implications than GDP forecasts alone.
We get asked almost every single day: will the United States enter a recession? Yes, or no? The simple but rather unhelpful answer is that we do have a recession in our base-case outlook for the United States because we see two quarters of negative GDP back-to-back and that satisfies the technical definition of a recession. And yet, as much as we have confidence in our outlook, we also feel that this binary line of questioning—recession/no recession—it isn’t helpful. It’s not going to prepare investors for what lies ahead in the next 12 months and beyond. We need a more thoughtful approach. We’ve put together a framework for how to think about the state of the world, how the United States will traverse a recession, and how investors need to position around it – we’re happy to share that with you.
- Frances Donald, Global Chief Economist and Strategist, Manulife Investment Management
Focus on momentum, not recession labels
Whether or not economic activity has contracted to the extent that it fits the official definition of recession is much less important than the decline in growth momentum that lies ahead. In our view, lending, consumer activity, capital investment, and, among other things, earnings will weaken in the coming six months. These developments are likely to be far more relevant to investors than the mathematical computation of a lagging economic indicator. While it’s plausible—in an alternative scenario—that the math works out and we narrowly escape the technical definition of a recession, the difference between, let’s say, for example, a 0.2% contraction and 0.1% GDP growth is unlikely to register with investors. In fact, we believe the latter scenario will also represent a more difficult environment for risk assets.
2 Monitor factors that could alter the next recession
Desynchronization: running on separate cycles The U.S. and global economies are currently heavily desynchronized across a range of factors. Crucially, the U.S. (and global) manufacturing and services sectors are running on separate cycles in a way that could see U.S. manufacturing recover even as the services sector weakens in the next six months. This environment could lead to sector- and company-specific opportunities even as the broader economic environment deteriorates. |
Labor hoarding: jobless rate could stay low We believe that labor shortage is a structural issue that will continue to pose an important challenge to businesses even as recession risk rises. While it won’t necessarily prevent higher unemployment rates in the coming year, labor hoarding may become more commonplace, which could mean a less pronounced rise in the unemployment rate than in past recessions. |
Heightened uncertainty: a different set of worries It’s worth underscoring that we’re operating in an environment defined by heightened geopolitical risk, pronounced supply-side-driven inflation, and more frequent and severe weather events. From an academic point of view, there’s no doubt in our minds that these factors will distort and test our understanding of recessions. |
3 The U.S. economy can slip into a technical recession and still be the cleanest dirty shirt within a global context
Where investors are concerned, economic activity is mostly viewed in relative terms (versus its regional and/or global peers). Without a doubt, a U.S. recession/slowdown will present a more challenging investment backdrop domestically, but even in that instance, the United States—in our view—is still likely to be the cleanest dirty shirt as the global economy shifts into lower gear. Europe, for instance, may stumble through an even worse 12 months, and we expect other developed economies such as Canada and Australia to experience deeper contractions due to their sensitivity to elevated interest rates. Emerging markets are also likely to struggle under the weight of higher oil prices, slower Chinese growth, and a strong U.S. dollar. It may sound counterintuitive, but within that context, a forecast calling for a U.S. recession is still compatible with the view that U.S. risk assets can still perform well globally, as we had outlined in our Multi-Asset Solutions Team’s asset allocation views recently.
4 A mild recession could be less challenging than stagflation
In our view, a recession in the coming months may not be the worst-case outcome for investors. Consider a standard recession scenario: growth declines, central banks cut interest rates, leading to a sizable recovery in growth. For most medium- to long-term investors, the pain is typically most acute in the near term while the opportunities could translate into gains in the longer term across asset classes. The alternate soft-landing scenario that we keep hearing about—one in which growth slows but not in a material way—may at first glance seem less negative, but could produce a more challenging investing environment in which growth declines while central banks continue to hang on to their hawkish bias. In such a scenario, growth’s likely to stagnate and a meaningful economic rebound is unlikely to materialize. In our view, an environment where the economy manages to dodge a recession but gets stuck in a prolonged period of <1% growth could well be more challenging to investors.
5 Why an investor’s investment horizon could be important
Finally, investors' investment horizon makes a material difference in how they should handle a recession. While we spend a lot of time examining recession risk, we devote just as much time thinking about what the postrecession rebound might look like. We believe that the longer-term outlook is one characterized by higher-quality growth, slightly higher inflation, and interest rates that are higher than what we’ve gotten used to in the post-global financial crisis environment. From an asset allocator’s perspective, it’s fair to say this typically translates into a bullish medium- to long-term investment outlook.
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