Chris Clothier, Co-CIO, CG Asset Management, commented:
“There are signs that the US economy is slowing sharply and the chances of a recession in the US over the next 12-18 months have increased significantly. There are several indicators that are supportive of this view:
· Savings rate – the US savings rate is low, implying that lower-income consumers are struggling to make ends meet.
· Unsecured credit – delinquencies are rising, credit card and auto delinquency are now at levels not seen since 2011.
· Labour market – the labour market is slowing which inter alia has resulted in the Sahm Rule being triggered. Hiring rates are at levels consistent with a recession.
· Capex orders – year-on-year capex orders are flat in nominal terms.
· Dis-inversion of the yield curve.
“This last point is slightly counterintuitive, after all the conventional wisdom is that an inverted yield curve is a harbinger of recession. Whilst true, the picture is slightly more complex: an inverted yield curve is a signal that the bond market believes that a recession is likely in the short to medium term because it implies that interest rates will be lower after 2 years than for the next two years.
“However, dis-inversion means that the bond market thinks the recession is actually here, and that the Fed will have to cut rates aggressively, leading to lower interest rates in the near term compared to the longer term. This pattern of inversion => dis-inversion => recession has occurred before each of the last three US recessions.
“We think that the bond market is only half right: the slowing economy means that rate cuts will be warranted. However, we believe inflation will prove stickier than the market expects, which will reduce the Fed’s latitude to act. Conversely, the equity market is looking increasingly out of sync with the bond market. The S&P 500 is at record highs, valued at 24x current year earnings, and pencilling in 14% earnings growth for next year.
“We are siding with the bond market and therefore, at the margin, trimming risk exposure in our funds.”
