Investor fears of US recession are ‘overblown’

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Fears over the possibility of the US plunging into recession and bear market are being overdone claims Morningstar, despite global markets having endured one of their-worst ever starts to a year.

While concerns regarding China, emerging markets and oil prices have far from disappeared, the impact from negative interest rates, coupled with growing fears over the strength of the world’s largest economy have taken centre stage.

Morningstar investment strategist Andy Brunner says that in the early part of the year, investors became increasingly concerned about “slowing developed economy growth” which only served to heighten fears that signs of financial market distress, particularly in the financial sector, might carry “a darker message”.

The past week has seen shares enjoy some respite, but the S&P 500 is now down by more than 2 per cent since the start of 2016 to 23 February, while global markets as measured by the MSCI AC World index have fallen by 3 per cent.

However, at one point they had nosedived by 8 per cent and 10 per cent respectively.

While investors’ primary concerns are centred on the prospects of a US recession, Brunner urges that the degree of equity market decline, and particularly credit spread widening, is indicative of a far greater likelihood than currently implied by recession risk models.

“Most currently indicate a 20-25 per cent probability of US recession within 12 months,” he adds.

“The longer the financial market turmoil persists, however, the greater the danger of a recession becoming a self-fulfilling prophecy as capital market concerns drain consumer and business confidence. The current period of economic uncertainty is also being exacerbated by concerns about the potency of central bank policy.”

Neptune US Income fund manager James Hackman also believes concerns about the US have been exaggerated.

He says: “We believe that the US economy remains strong. GDP is growing at nearly 2 per cent on a real time basis, therefore we believe that fears of recession in the US as a whole are overblown.

“Consumer spending constitutes two-thirds of GDP, so while US unemployment is very low, payroll growth is strong, wage growth is accelerating and household balance sheets are in a good position a technical recession is unlikely.“

Notably the latest Bank of America Merrill Lynch fund manager survey showed anxiety over a potential US recession had replaced worries about the fallout from China, with 27 per cent of managers selecting it as their top fear.

The analysis noted too that for the first time since July 2012, fund managers’ global growth and profit expectations had both turned negative. This was reflected in manager cash holdings, which had reached their highest levels since November 2001, at an average of 5.6 per cent.

Brunner notes now that while fears over emerging markets and China may have taken a backseat, the financial sector has been dragged into the spotlight.

He says that given financials account for 20 per cent of the developed world index, should the sector fall by 20 per cent, the buying of defensives, such as utilities and telecoms, would need to be huge to counterbalance this decline as the latter sectors account for just 7 per cent of the index combined.

“Consequently these defensive sectors would need to rise by some 60 per cent to offset the negative impact of financials on the index,” adds Brunner.

He says that while equities have been significantly oversold there is now the possibility of a significant rally but he urges investors to focus on identifying assets that are fundamentally undervalued.

Brunner says: “While capital markets remain  volatile, investors are likely to require greater incentives to fully re-engage in equity markets.

“Overall we favour a neutral position in equities and believe the best long-term opportunities are to be found in Europe, Japan and parts of emerging markets.”