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Societe Generale's strategists fear that the next recession will come sooner than everyone else thinks.
In fact, they are so perplexed by the data they consult that they say it's time to rethink how Wall Street is predicting recessions.
"As the current cycle has been exceptionally long, investors seem to take for granted that there can always be another expansion," said a team of strategists including Arthur van Slooten in a note addressed to customers.
He continued, "Over the past three years, recession forecasts have generally been set" for the next year, "and then redistributed." Maybe 2019 is the year we should go reckon that the next recession might be tighter than initially thought. "
The first widely used recession indicator that SocGen monitors is the yield curve, or the difference between interest rates on 2-year and 10-year notes. This gap has contracted to its lowest level since the last financial crisis and its zero-reversal preceded each US recession since the 1960s.
The second, less well-known warning sign is their proprietary news feed indicator. It is based on a number of news articles dealing with economic strength as a percentage of all news. It weakens as bearish media coverage increases and is used as a leading indicator of growth.
Both indicators are illustrated in the table below.
Read more: The most accurate economic forecaster in the world shares the major risk that he sees differently from most experts – and how investors can benefit from it
The slowdown in global industrial production, partly attributed to the US-China trade conflict, partly explains why the news flow was more bearish.
SocGen compared its proprietary indicator to global and US industrial production and came to similar downside conclusions. The graph below shows that the dark coverage of the global economy has generally followed the evolution of production and has been at the root of most contractions that have occurred since the late 1990s.
SocGen, which remains specific to the United States, appears to be at the forefront of a contraction in manufacturing output, as measured by the Purchasing Managers Index of the Institute for Supply Management.
More Gold Loop?
The current rebound in equities seems to run counter to the idea that the recession is fast approaching. After all, the sale took place at the end of last year because investors were worried about two breaches of their portfolios: a slowing of economic growth (and subsequently profits) and a Federal Reserve that would did not interrupt his rate hikes.
The stock rallied this year after receiving Fed badurances that it will be attentive to the markets. But van Slooten is not convinced that the Fed can create a fertile environment in which financial conditions are neither too hot nor too cold.
"While the use of its right of patience by the Fed has already paved the way for a strong recovery of the stock markets (+ 16.4% since the low points of December, the strongest recovery in the market since 2010) it is not the return of Goldilocks, "he said. .
He added that the Fed's more accommodative stance should at least cast doubt on the course of the end of this cycle.
"In our opinion, profit warnings, defaults and increased volatility are likely to be the dominant themes of the next 12 months," van Slooten said. "This could be good for Treasury securities but not necessarily for credit, equities or the US dollar."
Read more:The next recession could force the Fed to lower interest rates in negative territory. Here is what it means and how it could affect you.
Sooner or later
While the Fed's policy counts for investors' portfolios, it is far from the only consideration to be taken into account. That's why some other strategists do not fear an impending recession.
Like SocGen, the main investment office at UBS is monitoring the recession, but not with the same apparent sense of immediacy.
In a recent note, UBS has exposed some grounds for concern. For example, the New York Federal Reserve's recession probability indicator, based on the 3-month / 10-year yield curve, is at its highest level since 2008.
However, the company said the yield curve may not be a reliable precursor to the recession this time around.
"Looking at the statistics, reversing the US yield curve can hurt your portfolio if it forces you to sell stock by reflex," said Vincent Heaney, a strategist at UBS. "History shows that on average since 1960, after reversing the 2-year / 10-year yield curve, the S & P 500 returns 29% before reaching a record high. . "
Even the ISM manufacturing index quoted by van Slooten is not a perfect indicator. Since the 1980s, it has contracted with every recession and even hinted that two of the three. But there have been a lot of contractions – including one as recent as in 2016 – that have not been followed quickly by recessions.
Whatever side you are in, it is clear that Wall Street is warming up before the next recession. Van Slooten and his colleagues are simply not convinced that good times will last a lot longer.
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