Among the many uncertainties facing investors, the risk of a U.S. recession seems to be rising each day as tumultuous bond and stock markets undermine confidence. A scorecard actually exists that purports to track how many times corporate executives utter the dreaded “R” word (recession) on earnings calls with analysts. Recently, the number of references to the word recession is at the highest level since 2009. Surely, business confidence overall has suffered, especially for managers of large companies who are witnessing a strong dollar, declining export demand and outright collapses in a variety of commodity prices.
So what are the stock and high-yield bond markets really telling us about the future of the U.S. economy? First, the stock market has only successfully foreshadowed a recession once in the last 35 years (in 2001, the shallowest recession on record, which was eventually revised away). Second, the high-yield bond market has a mixed record in predicting economic downturns. Undoubtedly, some parts of the high-yield bond market have suffered major price declines, but much of the damage deservedly resides in names associated with the oil, metals or mining business.
Unfortunately, when it comes to predicting recessions, the track record of economists and other market prognosticators is embarrassingly wrong most of the time. In order to be more successful, it is critical to determine consumer behavior. The consumer alone dictates approximately 70% of economic activity in the U.S. as measured by gross domestic product (GDP).
For several reasons, we believe the consumer will continue to drive the U.S. forward and keep us out of a recession in the near future. Real consumption rose 3.1% in 2015, the best pace since the home equity borrowing binge fostered the credit boom of 2005. This time around, consumers are both spending and saving money at the same time. And we know savings can ultimately be considered deferred consumption.
Furthermore, recent employment statistics are quite encouraging. Not only are more people finding jobs, but existing workers are also working a longer workweek and earning more money per hour as well. As the number of aggregate hours worked expands, it correlates very positively to GDP growth. Coincidentally, the latest household survey of employment showed the most new job growth among 25-to 34-year-olds in 25 years. This is a huge positive for an age group that drives household formation and related spending.
In summary, there are three important reasons why it is really hard to tip the U.S. economy into a recession anytime soon:
1. Real personal income is rising
2. Lower oil prices alone have never caused a recession in the U.S.
3. No recession has ever started with today’s low unemployment rate of 4.9%
Asset allocation strategies must be built to withstand a multitude of uncertainties. As it pertains to growing near-term U.S. recessionary fears, we believe that particular uncertainty is misunderstood. We will continue to revisit our thesis on those fears, as we do with the theses behind all our views, and we remain persuaded that both equities and U.S. high yield offer attractive risk/return profiles in the medium term.
