This article is part of Morningstar's "Perspectives" series, written by third-party contributors. Here, Kevin Gardiner, Chief Investment Officer, Europe at Barclays considers the likelihood of a shock recession.
They are two of our “desert island” stats: the US manufacturing ISM survey, and retail sales data, for January. We learned about the former last week – new orders fell at their fastest since 1980. This week we learned that core retail spending fell, from a downwardly-revised December a revision which trimmed estimated US fourth-quarter GDP growth. We’ve always said we take these indicators seriously, so what now?
January's weakness reflected the extreme but temporary weather
Well, this may sound like special pleading, but you shouldn’t respond even to your favourite economic signals in a mechanistic, unthinking way. Context and perspective are hugely important in investing. There is no great Mystery – in the religious sense of the word – in finance; which does not mean that markets are predictable. There is no infallible, all-explaining model waiting to be discovered. The economy is likely less sophisticated than the analysis we inflict upon it, and the importance of expectations renders statistical relationships fluid at the best of times. We have to deal with the shifting facts, and keep an open mind.
In this instance, the falls may have been disappointing, but the levels of both indicators are still consistent with ongoing growth. The headline ISM index remains above 50 (GDP breakeven is around 45), and the 3-month trend in retail spending is still positive, even net of those revisions. And there are good reasons for thinking that some of January’s weakness reflected the extreme but temporary weather that froze much of the east coast and mid-west.
More importantly, the bigger context is currently one in which there are few obvious signs of private sector excess warranting a recession. There is if anything a backlog of economic opportunities still to be made good after the worst decade of US growth in half a century. They are most visible in housing and capital spending, but they extend across households and businesses, and they exist because growth in productive potential has continued all along, driven by the prosaic interaction of the learning curve and new technology. The relevant investment perspective is one that places the current valuation of securities in this context – and for us, it suggests that it is too soon to be bailing out of stocks, or chasing the rally in bonds. Indeed, as of last week stocks are again our tactically-preferred asset.
This may be a frustratingly ad hoc and imprecise response for those who yearn for the authority and spurious precision offered by the many mysterious models on offer from the grand inquisitors of high finance. How much easier it is not to think for ourselves, but to sit back and be advised that all we have to do is look to an obscure accounting identity, listen to a dogmatic economist, or pay attention to an esoteric valuation measure, for the answers. And the more exotic the investment, the greater the allure of the mystery: what self-respecting fund manager is going to tell their client that they probably need to get that perspective right, research fewer securities and trade less?
But the reassurance offered by financial dogma can be expensive, and the opportunities available on our doorsteps can be every bit as worthwhile as those frontier market bonds.
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