All eyes are on the US Federal Reserve ahead of its meeting today, when it is expected to keep rates on hold. As fund managers and investors mull the likelihood of a US recession versus the consensus expectation of a soft landing, it can pay dividends to think outside the box, rather than relying on the same economic indicators as everyone else.
Oliver Blackbourn, a multi-asset portfolio manager at Janus Henderson Investors, thinks the risk of a recession is much higher than the market has priced in.
Consensus expectations that the US will avoid a recession and achieve a soft landing are based on positive economic data, such as better than expected payroll numbers, but Blackbourn told Trustnet that investors need to widen their lenses, noting the US could plausibly slide into a shallow recession without any significant shocks occurring.
“One of the biggest failings in finance is often a lack of imagination,” Blackbourn said. “You can have a recession without having the big imbalances that were around prior to 2008.
“I think the risks of recession rise meaningfully throughout 2024 as tighter monetary policy has longer to take effect. More borrowers will require re-financing at higher interest costs as time goes by and fixed term lending matures.”
It takes more creativity to imagine why the US economy is not yet out of the woods and what might happen if the US equity market runs out of steam. As long as corporate earnings continue to rise, the S&P 500 will keep going, Blackbourn said, with the music stopping when earnings fall.
Even a shallow recession in the US could be quite detrimental to the S&P 500, which has become more sensitive to economic downturns over the past 25 years because companies are more levered, both financially and operationally.
“We’re worried about an inflection point in earnings,” Blackbourn stated. “If we see cracks in the US labour market, that would be a sign to get more negative about the world.”
Higher borrowing rates in the US mean access to credit for smaller companies in particular is deteriorating. “If companies can’t borrow, they can’t expand and hire people,” Blackbourn explained. “These small companies are the backbone of US employment.”
Against this backdrop, Blackbourn said several asset classes are failing to adequately price in potential risks, which makes investment decisions difficult.
“We’re finding it hard to have very strong convictions. Markets are mispriced for the risks that are out there. It’s difficult to put sizeable bets on,” he explained. “You would expect [equity] markets to price in a downside risk to company earnings. You might expect credit spreads to be wider and valuations lower.”
To add to the problem, several asset classes in which he would ideally like to invest look overvalued, such as infrastructure, renewables and higher quality property, which could act as risk-off buffers to portfolios.
The multi-asset team bought some gold this year having not owned any for several years. Gold provided diversification recently when government bond yields did not; it should protect against tail risks, such as a US government shutdown, and may also afford some protection if there is a spike in oil prices.