Despite rampant talk of economic recession last month, it’s our position that global conditions are not inexorably leading in that direction.
Worldwide reporting on the inversion of the yield curve in August—when investor reward for US Treasury bonds briefly favoured short-term holders (two-year) over long-term ones (10-year)—focused on its history as an indicator of impending recession.
What the media didn’t fully explain was that we’re in an extraordinary period with exceptionally low rates aimed at avoiding recession. Central banks continue their efforts to keep economies stimulated and growing. Because of this we expect the investment cycle to be extended for a while longer although the growth outlook will be much softer than we have come to expect.
To sum up, even noting increased risks such as companies’ lower earnings expectations, we are in a very different environment to past periods of softening growth, with rates globally at record lows (some banks in Europe even paying customers to take out loans).
There are still positive indications of economic activity, such as:
- US mortgage applications have improved as rates have dropped (as has auction clearance rates in major Australian cities)
- Investment-grade credit spreads are still reasonably tight (they usually widen sharply before sharemarkets see a recession coming)
- Surveys show US credit supply is not tight (with tight conditions usually seen before a recession).
Furthermore, valuations of shares are now returning closer to our estimate of ‘fair value’. With bond yields so low that even with listed companies reporting flat earnings, shares look relatively more attractive.
We’re looking for two more developments to give greater reassurance that recession risks will abate:
- For central banks to ease rates further to support the investment cycle for longer
- The US bond yield curve to steepen a little in the months ahead in response to rate cuts, more Chinese stimulus, and easing measures in Europe.