Investors shouldn’t fear the increasing likelihood of a recession in the US and Europe in the coming months due to the opportunities it can offer.
While timing remains uncertain, AllianzGI expects it to arrive either later this year or early next – given that price pressures are sticky, in turn forcing central banks in developed markets to keep interest rates higher for longer.
“We think a recession may be both unavoidable and necessary to help the major economies reset after the lingering repercussions of the Covid-19 pandemic and the Ukraine war,” said Stefan Hofrichter, head of global economics & strategy at the fund house.
The good news, he added, is that a downturn may offer potential entry points for investors as equity market valuations adjust and economies begin to recover. “It can be helpful to think of recession as a pressure relief valve that reduces the risk of economies overheating.”
“Importantly for investors, it could create conditions for a revival in risky assets,” said Hofrichter.
A matter of time
AllianzGI sees various leading indicators as consistent with its recession call.
Perhaps most significantly, said Hofrichter, yield curves are inverted, resulting in short-term bonds yielding more than longer-term instruments with the same credit risk profile.
“In other words, investors expect a fall in longer-term interest rates because economic conditions are set to worsen,” he explained.
Historical evidence also points to an inversion in the US government bond yield curve as being a harbinger of recession in the world’s largest economy.
At the same time, the US real estate market is slowing as a period of price rises comes to an end. If property prices fall faster than expected, AllianzGI believes the result could be a more marked economic slowdown than markets anticipate.
Readying for recession
In preparation for such challenging economic times, Hofrichter encourages investors to be patient amid slowing, and then shrinking, growth, since firms that are more resilient may be able to prosper.
As a result, downturns may provide opportunities to add to portfolios, he added. “Earnings expectations generally reach the bottom during a downturn. That point could provide a potential entry for investors as stock prices “climb a wall of worry” even in the face of market negativity.”
Investors might also benefit from a potential rebalancing of those US equity valuations that appear high today by historical standards.
“With a recession on the horizon, it is a time to be agile and adaptable by looking through the economic challenges towards the opportunities,” said Hofrichter.
Asia decoupling
AllianzGI also sees specific opportunities emerging in Asia regardless of any recession in the US and Europe.
“We expect Asian central banks to start lowering interest rates in the coming quarters, helping support flagging economic growth,” said Christiaan Tuntono, senior economist for the firm in Asia Pacific. “In effect, they will ‘decouple’ from US and European policymakers continuing to combat persistent inflation.”
Rate cuts by Asian central banks will likely come, he added, because of the impact of lower global growth in slowing demand for Asia’s goods and services and due to waning domestic consumer spending. Further, inflation is falling faster in Asia than in the US and Europe.
For investors, Tuntono said Asian local currency fixed income stands to prosper from expected disinflation and the decoupling of Asian central banks.
In equities, he sees potential value in less export-oriented economies like Japan, India and Indonesia in anticipation of their central banks either starting to lower rates or keeping them lower. Also, he added, a larger-than-expected stimulus from the Chinese government may present tactical long-term opportunities in China.
