Joy Replaces Gloom Among Global Investors as Recession Risk Fades

(Bloomberg Businessweek) -- Three months ago the economic outlook seemed dark. The U.S.-China trade war refused to go away, and there were signs of weakness in Germany, the European Union’s economic linchpin, as well as the U.K., which faced a messy exit from the EU. On Aug. 14 major U.S. stock indexes fell 3%, spooked by a steep drop in long-term bond yields. “Investors are increasingly selling first and asking questions later,” one analyst told Bloomberg.

Pity the investor who panicked and sold off, or the executive who shelved a planned expansion—since August, the economic outlook has brightened considerably. Stock indexes in the U.S. set records almost daily in early November. The mood has gone from gloomy to exuberant. “The bulls are back ... global recession fears vanish,” wrote investment strategists at Bank of America Merrill Lynch in a Nov. 12 note to clients.

In August, nearly three times as many global fund managers surveyed by Bank of America Merrill Lynch expected weaker global growth over the coming year as expected stronger growth. In November, the optimists actually outnumbered the pessimists.

True, investors and money managers have been known to overreact. Things weren’t as bad as they looked in August, and they may not be as good as they seem now. “The baseline forecast moves relatively little as new data come along,” says Chris Varvares, co-founder and senior managing director of Macroeconomic Advisers in St. Louis. “The risk premium is what’s moved around, reflecting investors’ perceptions of risk.”

Still, there’s something real underlying the improved sentiment. What bearish investors overlooked in August is that monetary policy was already shifting. In December the Federal Reserve was tentatively planning on three quarter-point increases in the federal funds rate in 2019. It put those on hold and then cut three times, with two of the cuts coming since August. That’s quite a U-turn.

The European Central Bank has also become more dovish. It resumed buying bonds to stimulate growth this month. The Bank of Japan has done less, but at least it kept its benchmark interest rate in negative territory, despite pressure to raise it. Morgan Stanley recently noted that 20 of the 32 central banks it tracks had eased monetary policy over the past year. “You don’t want to bet against the world’s largest central banks,” says Christopher Smart, chief global strategist of Barings, the investment management company.

The U.S., with its huge appetite for imports, has remained an engine of global growth. The American economic expansion is in its 11th year, a record. Consumers have been buoyed by solid wage growth and low unemployment, says Edward Yardeni, the president and chief investment strategist of Yardeni Research Inc. The pessimistic take on the U.S. is that business investment has been weak, but Yardeni says the numbers look better outside the oil patch—health care, tech, and finance are all healthy. “I do see many companies expanding and investing for productivity,” says Christopher Johnson, president of global financial services at Pitney Bowes.

The geopolitical situation has also stabilized a bit since summer. The trade war hasn’t intensified. China’s economy has slowed, but it hasn’t crashed. In Europe, the risk of a chaotic, no-deal Brexit has diminished, while third-quarter data showed that Germany narrowly avoided what would have been its first recession in six years. Morgan Stanley, in a Nov. 18 report, wrote that “trade tensions and monetary policy are easing concurrently for the first time in seven quarters.”

A lot of what’s changed is financial. The scariest omen in August was the plunge in U.S. long-term bond yields. During the trading day on Aug. 14 the yield on 10-year Treasury notes briefly fell below that on 2-year notes—a reversal of the normal state of affairs, in which investors get paid more to hold long-term securities. So-called inversions used to be a sure harbinger of a recession. But as Bloomberg Businessweek wrote that month, they’re not as scary as they used to be, because even in ordinary times the 2-and 10-year yields are close. In any case, the yield curve has reverted to its normal shape.

The stock market rebound since August is both a reflection of the improving outlook and a partial cause of it. Higher stock prices make households more willing to spend and businesses more willing to invest. But we’re not out of the woods yet. Are easier monetary policy, strong consumer spending, and a robust stock market “enough of a reprieve to kick-start some business investment, which has been tailing off for a year or two?” asks Barings’s Smart. “It’s hard to see the rosy employment picture continuing for much longer while business investment is lagging.”

In other words: Is the recent improvement strong enough to be self-sustaining, or the last gasp of an expansion that’s past its prime?
 
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To contact the editor responsible for this story: Cristina Lindblad at mlindblad1@bloomberg.net

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