The “gradually” maturing investment cycle – what is the risk of a US recession?
The long and strong US bull market
Next month, the cyclical bull market in US shares that started in March 2009 will be nine years old. See the next table.
Source: Bloomberg, AMP Capital.
This makes it the second longest since World War Two and the second strongest in terms of gain. And according to the US National Bureau of Economic Research the current US economic expansion is now 104 months old and compares to an average expansion of 58 months since 1945. This naturally begs the question whether recession is around the corner leaving the US and hence global shares vulnerable to a major bear market?
The investment cycle is maturing
The next chart is a stylised version of the investment cycle – the thick grey line is the economic cycle.
Source: AMP Capital
A typical cyclical bull market in shares has three phases: scepticism – when economic conditions are weak and confidence is poor, but smart investors see value in shares helped by ultra-easy monetary conditions; optimism or the “sweet spot” – when profits and growth strengthen and investor scepticism gives way to optimism while monetary policy is still easy; euphoria – when investors become euphoric on strong economic and profit conditions, which pushes shares into clear overvalued territory and excesses appear, forcing central banks to become tight triggering an economic downturn, which combines with overvaluation and investors being fully invested to drive a new bear market.
Typically, the bull phase lasts five years. However, “bull markets do not die of old age but of exhaustion” – their length depends on how quickly recovery proceeds, excess builds up, inflation rises and extremes of overvaluation and investor euphoria appear.
This process has taken longer than normal following the GFC because periodic crises or aftershocks from the GFC – eg, the 2010-2012 Eurozone sovereign debt crisis and the 2015-16 global growth scare both of which were associated with mini bear markets globally and 19% and 14% falls in US shares respectively. This combined with post GFC consumer and business caution have prevented the global economy from overheating and excesses building and share markets going into euphoria, that then sets the scene for the next major bear market.
However, this is starting to change. Global growth forecasts have stopped being revised down and are now being revised up. Global growth this year and next will likely be around 3.9% which is above potential. So global spare capacity is starting to be used up.
Source: IMF, AMP Capital
Fiscal austerity has given way to fiscal stimulus – at least in the US (with tax cuts and the removal of spending caps) – which with a lag will further boost growth. Inflationary pressures are building in the US – which is further advanced in the economic cycle than Europe, Australia and Japan (see the first chart) – with a tight labour market, rising wages growth and accelerating import prices (flowing from the falling $US) and producer price inflation.
Source: Bloomberg, AMP Capital
Not at the top yet
But it’s unlikely we are at the top just yet. Historically 10% or so share market pull backs (like the one two weeks ago) are normal. But whether the US is about to enter recession is critical to whether the US (and hence global) bull market in shares is about to end. Looking at all 10% or greater falls in US shares since the 1970s (see the table in Correction time for shares?) share market falls associated with recession tend to be longer lasting with an average duration of 16 months as opposed to 9 months for all 10% plus falls and deeper with an average decline of 36% compared to an average of 17% for all 10% plus falls.
So whether a recession is imminent or not in the US is critically important in terms of whether we will see a major bear market or not. In fact, the same applies to Australian shares.
Our assessment is that a recession is not imminent in the US or globally (or in Australia – a separate issue). First, the post-GFC hangover has only just faded with high levels of confidence helping drive stronger investment and consumer spending.
- overall private sector debt growth is modest in most countries (except for corporate debt in the US and China);
- while investment is starting to pick up globally, there is no sign of overinvestment. While the US is further advanced, even here business investment (excesses in which preceded the tech wreck) and residential property investment (excesses in which preceded the GFC) are around their long-term averages relative to GDP.
Source: Bloomberg, AMP Capital
- capacity utilisation is rising and inflationary pressures are building in the US but inflation is not a problem yet and it’s not an issue in other major countries. Core inflation in major countries ranges between 0.3% in Japan to 1.5% in the US.
Fourth, monetary policy is not tight globally, even in the US where the Fed has been tightening for two years: the Fed Funds rate is below nominal GDP growth – which is a sign of lose monetary policy; and the yield curve (or the gap between long term bond yields and short-term interest rates), which has always gone negative ahead of past recessions, is still positive.
Source: Bloomberg, AMP Capital
What to watch?
More volatility should be anticipated, and the fickleness of investor confidence means we can’t rule out another crash like in 1987. But despite this we still appear to be a fair way from the peak in the investment cycle so the trend in share markets likely remains up. Non-US shares and economies are less advanced in their cycles and provide opportunities for investors.
Dr Shane Oliver
Head of Investment Strategy and Economics and Chief Economist
About the Author Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital’s diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.
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Original Source: Produced by AMP Capital Ltd and published on 21 February 2018. Original article.