Do market conditions suggest a recession is coming?



​In this recent interview with MarketWatch, Janus Henderson Director of Research Carmel Wellso talks about why it may be premature to expect a recession this year or next.

About 80% of S&P 500 Index companies reported first-quarter earnings that exceeded analysts’ estimates. Yet the US stock index dropped 1.2% in the year through March 2018 as investors grew worried that a recession was imminent.
The trigger was a return of implied volatility, as the CBOE Volatility Index (VIX) briefly surged to 37 in February after averaging 11 in the previous 12 months. While the S&P 500 rose or fell by more than one percentage point only eight times in 2017, already this year it has swung by that magnitude on 35 days. That has led some to question whether 2019 will mark the end of the second longest bull market.
But there are just about optimal conditions for active stock pickers, with rates rising, real gross domestic product (GDP) growth of 2.2% in the first three months of 2018 in the US and core consumer price inflation at the same level.
Sure, there are risks, such as higher gas prices and healthcare inflation. On a macro level, the main uncertainty surrounds trade talks between the US and partners including Canada, Mexico, China and Europe, but it is perhaps more likely that the political to-and-fro should give pause rather than be seen as the harbinger of an outright correction.
Tax cuts
Buoyed by tax cuts and the ability to repatriate overseas cash at attractive rates, many US companies are investing for growth, particularly through increased capital expenditures, and mergers and acquisitions. The benefits of this have yet to be felt.
The US consumer is also showing confidence. In April, 163,000 homes were authorised for construction but not yet started, 16% more than a year earlier, indicating demand is holding even after seven interest rate increases by the US Federal Reserve since December 2015 and as material and labour costs rise.
That is a boost for companies such as PulteGroup, which trades on a 2020 price-to-earnings (P/E) ratio of seven compared with a two-year forward P/E of 14 for the S&P 500. Pulte targets high-growth sectors such as first-time buyers and baby boomers downsizing.
As always, there are potential pitfalls.
Retailers face margin pressure because of an inability to pass through rising costs due to online competition. But while consumer staples show little upside potential versus their downside risk, select discretionary names look more appealing. Home Depot is well-placed to take advantage of the strength in housing and higher disposable incomes feeding through to remodels and upgrades, plus it has the bonus of being more Amazon-proof (who orders a bag of cement online?).
Others in the consumer discretionary space that may enjoy a boost from rising disposable incomes include travel-related companies such as Norwegian Cruise Line.
Banks buoyed
As interest rates and inflation rise, momentum can tip to some value categories. Rising net interest margins and less regulation may boost banks such as Citigroup, JP Morgan Chase and Bank of America while increased volatility may help trading revenues at the likes of Goldman Sachs.
Other value players in long-unfancied industrial sectors — such as Rio Tinto, Siemens Caterpillar and Japanese semiconductor wafer makers Shin-Etsu Chemical and Sumco — are enjoying greater pricing power because of capacity constraints and rising demand. Indicators of this include a three percentage point rise in US industrial utilisation since December 2016 to 78% of capacity, causing longer wait times for raw materials.
Back on the growth front, select technology stocks continue to appeal because of strong revenue and earnings, despite often elevated valuations. We are at the outset of a decades-long digital transformation of the economy, driven by artificial intelligence, cloud computing, mobile connectivity and the internet of things (IoT).
Chip stocks
That potentially creates a powerful tailwind for semiconductor makers such as Taiwan Semiconductor, Xilinx and Microchip Technology; semiconductor-equipment makers such as ASML and Lam Research; connectivity providers including Amphenol and TE Connectivity and the large cloud computing platforms Alphabet, Amazon and Microsoft.
Outside the US, every European Union member state expanded in 2017 for the first time in ten years, giving the bloc its fastest growth since 2007. Following a bump in the first quarter on problems including currency appreciation, bad weather, strikes and capacity constraints, growth is forecast to strengthen again in the three months through June. Exporters such as Germany, France, Italy and Spain may get a boost from the 4.4% depreciation in the euro against the US dollar since 30 March after the single currency surged 17% against the greenback in the previous 15 months. Being a few steps behind the US in its recovery, Europe perhaps has a longer runway than many anticipate.
There is also little to indicate trouble in China, where GDP is rising at 6.8% annually and where technology companies such as Alibaba and Tencent continue to merit their valuations on growth expectations, even as both stock prices doubled last year. Alibaba forecast a 60% leap in revenue for the year through March 2019, and Tencent delivered a 61% surge in net income in the first quarter.
All of which suggests it may be premature to talk of a recession this year or next.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

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