The Money Marketing Podcast: Are we
really at risk of global recession?
By Valentina Romeo 17th February 2016 2:32 pm 17th February 2016 3:18 pm
We are less than two months into 2016, and yet we have seen markets recording their worst weeks for
many years. The recent volatility begs the question whether these setbacks will ultimately lead to
another global economic recession.
Investment reporter Valentina Romeo speaks to M&G fund manager Stephen Andrew
and Axa Wealth head of investing Adrian Lowcock to understand why a recession is unlikely to
happen anytime soon.
Andrew argues there are not “exhaustive analyses” to prove we are heading towards a recession and
despite the slow pace of US growth, economic data from the Federal Reserve proves the country is
not on the brink of a crisis.
Lowcock adds although saying China’s slowdown remains a worry for many economies, risk alone
will not lead to a recession, especially in the UK.
How big is the risk of global recession?
There is a saying in finance that markets create their own propaganda. This means if markets
 are down, investors focus on the economic evidence that supports this. Recently, this “evidence”
 has come from global manufacturing data, which has been weaker, but investors have ignored the
services side of economies, which have been stronger. Services in the major economies account for 75
per cent of GDP and even in China are now believed to represent over 50 per cent.
In Europe, the weak euro, low oil price and easy monetary policy, together with continued signs of
less fiscal austerity, are resulting in falling unemployment and a pick-up in many of the peripheral
economies. In Japan, however, the government has recently reduced its GDP forecast for the
year. Abenomics has yet to deliver the expected amount of structural reform but, on the positive side,
wages are increasing.
When it comes to the emerging economies, there continues to be huge divergence between
commodity importers and exporters. Most of the attention is currently focused on China and whether
it is headed for a hard landing. The Western media continues to focus on the wrong statistics, which
show its economy in a poor light. While manufacturing and fixed asset investment continues to slow,
services continue to grow.
A different world
For investors, today’s world is miles away from that of previous regimes, so it is hard to make sense
of. Between 2000 and 2008 we were in a regime of increased leverage but since 2009 we have seen
the opposite. The effect of a deleveraging regime is slower demand, slower growth and lower inflation
globally. In such a world it is difficult to be sure of the business cycle investors should expect.
In a cycle where rates and economic growth stay low, there are reasonable prospects the upturn will
be longer and steadier (although slower), which should allow interest rates to remain at levels low by
historic standards and, even when increases occur, these will be modest. As a result, valuations in
asset classes such as equities can remain at higher levels as the discount rate used will be lower than
in previous cycles.
The catch for this is that because growth and inflation rates are expected to stay low, markets will be
extremely sensitive to small changes in either of these numbers. Weaker growth can lead investors to
fear a fall into deflation.
Areas of divergence
A key area of divergence is in monetary policy between the Anglo Saxon economies of the US/UK
and Europe/Japan. For investors in the US, rising rates have historically resulted in the market P/E derating. At the moment, however, earnings growth there is not strong enough to counteract this derating. Rising rates have also impacted currency markets and been a negative factor behind capital
leaving the emerging world.
On the other hand, Europe and Japan should remain favoured by continued easy monetary policy.
Both markets continue to offer investors upside outside of a global recession and are expected to
outperform.
There is also divergence between developed and emerging economies. While the recovery in
the developed world progressed in 2015, economic growth in the emerging economies slowed. Russia
and Brazil, two of the largest developing economies, are already in deep recession, with little sign of
an imminent pick-up in growth. Emerging economies today account for around 50 per cent of world
output at purchasing power parity, so developments there are much more significant than 20 years
ago.
What hope for growth?
Today’s market turmoil has led investors to question whether unconventional central bank policy will
actually deliver sustainable economic growth.
Looking at markets on a longer-term perspective, there have generally been two main drivers of
serious bear markets: recession and aggressive tightening of monetary policy. Neither of these
outcomes looks likely and perhaps a more balanced appraisal of the recent sell-off is that it was
valuation driven. It certainly occurred at a time when there was less valuation support for the market
than in other pullbacks in the post-crisis period. While the recession risk for the global economy in
2016 cannot be dismissed entirely it remains a low probability.
In this scenario, investors need to keep a level head and look to exploit market falls as opportunities to
selectivity top up equity positions if exposure is light. While markets should recover from these
levels, volatility is likely to continue until investors believe the end of unconventional monetary
policy will transition into sustainable economic growth. At present, markets are fearful and this could
persist until either economic data causes investors to reassess or there are signs of a policy shift that is
supportive of markets.
Graham O’Neill is director of RSMR