Amid widespread cautionary optimism, some economists say the global economy is still at risk of a recession, and that we may not be out of the inflationary woods quite yet. Guy Wagner, chief investment officer at Banque de Luxembourg Investments, or BLI, lays out the bear case.
“The fact that up to now the recession has not yet happened does not mean that it will certainly never happen,” said Wagner at a press event in Luxembourg last week. BLI manages assets worth about 15 billion euro.
Pointing to a slide showing data since 1970 on leading indicators and recessions, he showed that current data is in nearly as negative territory as 2020 and several previous recessions.
Two-year delay
“We can see that every time when the leading indicators were in such negative territory, a recession followed.” He explained there’s often a two-year delay between central banks raising their interest rates and a recession. He wondered out loud at the public discourse on the prospect of recession.
“It was never the idea to say that a recession will happen right away and the economy will go from 3% growth to negative growth in three months.”
Wagner also pointed to another sign that has pointed to recession: the time between the inversion of the rate curve, meaning when long-term rates drop below short-term rates and a recession. The rates inversion happened 13 months ago, longer than the 10 months between the inversion preceding the 2020 recession. “It’s not an exact science,” said Wagner.
Contradictory elements
The strength of the US economy last year and the negative leading indicators are contradictory elements, according to Wagner. “It’s a bit unusual in an economy that has shown proof of resilience that the leading indicators are pointing to a recession.”
How can this contradiction be resolved? Wagner said the leading indicators might start improving and this time, things being different, there will be no recession. Growth could sooner or later tip the balance in favour of the economy.
One possible factor, he explained, is the excessive savings built up by households during the pandemic when they earned money they couldn’t spend. Wagner pointed to a study he’d seen saying that this had amounted to 2.5% of GDP over three years.
“Some say it would also explain part of the current resilience,” he said.
Risk seems real
Wagner was at pains to say that his working hypothesis does not focus on an obsession with a recession. “Simply the risk of a recession seems real to me,” he said.
To support this view, Wagner pointed to data on employment in the services sector. He explained that the services sector is usually more stable than, for example, manufacturing. Even in a recession, he said, we continue to get our hair cut or eat at a restaurant.
“The only times when employment really fell sharply in services was during a recession.” He showed a slide showing that service sector employment has started dropping sharply. He cautioned that, as of today, a recession is clearly not anticipated.
No saviour economy
With possible future risks to the US economy evident in the data, one might be encouraged to think that another economy in the world will stimulate the US economy and help it to escape a recession. “Except that the rest of the world is very weak,” he explained, pointing to the eurozone being practically in recession as well as China, with Germany still weak.
“It’s a bit illusory to think that, in my view, that the rest of the world could become the locomotive of the global economy,” he said.
For Wagner, it’s hard to have a view on inflation today after the sudden central bank pivot towards rate cuts in 2024. He pointed to a slide overlaying the path of inflation since 2014 with the inflation between 1966 and 1983. It’s a close fit and shows that in that period, there was a first inflationary wave, which led to central bank rate cuts.
Second inflationary wave
“The central banks thought inflation was behind us, we lowered the rates and then there was a second inflationary wave that followed,” said Wagner, explaining that some think this could happen again.
He pointed out that the Fed has signalled its intent to cut rates “quite aggressively” this year “for a slightly political reason.”
Part of Wagner’s role at BLI is to manage the 1.4 billion euro BL Global Flexible EUR fund. The fund, which has a four star/neutral rating at Morningstar, is about 70% in equities with wide coverage, with bonds, gold companies and cash. About 27% of the fund is invested in European equities, with half invested in Switzerland. His bond allocation of 13.8% is exclusively in the US, where he also has 13.1% in precious metals.
“Bonds are in all cases American state bonds, with a relatively long duration,” said Wagner. “It is clearly this idea of protection against a recession.”
“The idea is to have a relatively balanced plan, independent of the economic outcomes,” he said.