Preparing for recession?

Is the recession coming or not? This is the question on which opinions are now divided among the analysts of investment houses but also the stategists of many Italian and international management companies, who are questioning themselves on the prospects of the world economy and especially those of the major western countries, from the United States to Europe, passing through Great Britain. It is no coincidence that the recession was also one of the underlying themes of the Salone del Risparmio 2023, scheduled from 16 to 18 May at the MiCo congress centre in Milan, where the managers of the main sgr and asset management companies active in our country gathered.

Although the topic is increasingly talked about, at the moment, macroeconomic data do not seem to signal a global recession at the gates. In fact, many data have turned out better than expected, at least in Europe. Moreover, in its latest spring forecast, the EU Commission raised its GDP growth estimates for the Eurozone in 2023 by a few tenths of a point, setting them at 1.1 per cent. Italy is expected to do even better than the rest of the continent, with GDP growing by 1.2 per cent year-on-year, against the 0.8 per cent previously estimated by the Brussels authorities.

Fund managers and members of the financial community do not seem inclined to indulge in too much optimism and are keeping their feet on the ground, especially looking at what is happening on the other side of the Atlantic. In the US, many still fear a mild recession in the coming months. In the first quarter of the year, US GDP disappointed expectations, stopping at a growth of 1.1% compared to the estimated 1.9%. Moreover, as anyone who has followed the financial news in recent months knows, there has been a new banking crisis in the US with the bankruptcy of Silicon Valley Bank and tensions over the fate of regional banks increasing fears of a credit crunch during 2023. Fewer loans to businesses and households could translate into a sharper-than-expected slowdown of the economy.

Moreover, it should not be forgotten that overseas inflation is falling but at the same time holding up: in April it grew at a rate of 4.9% year-on-year, the lowest in two years, but the core component (which does not take into account goods with more volatile prices such as food and energy) grew at a stable rate at 5.5%, in line with expectations. "Inflation, while below the highs, is still exceeding the monetary authorities' targets," says Stefano Negri, head of Quantitative Management and Unit Linked at Banca Generali, who points out that the main macroeconomic indicators are providing mixed signals.

"The labour market remains overheated," adds Negri, "the figure for new employees in the United States came out at 253 thousand new payrolls against the 185 thousand expected." In addition, Negri points out that the GDP growth estimate for 2023, driven by growth in the services sector, shows no real signs of abating for the time being. Even the manufacturing ISM in April (the survey of purchasing managers of companies, which reveals whether the production system is expanding or not), while remaining below the 50-point threshold, was an improvement on the March figure (47.1 points in April against 46.3 in the previous month).  On the opposite side, hinting at a possible recession is the inversion of the US and European rate curves. This is a situation in which yields on government bonds with a 2-year maturity exceed those with a 10-year maturity. This is an anomaly because bonds with shorter maturities, being less risky because they are less exposed to rising rates, normally have lower yields than those with long maturities.

Precisely because it is an anomaly, the inversion of the yield curve is seen by analysts as a sign of a coming recession. The market, in fact, expects the US central bank (the Federal Reserve) to keep interest rates at still high levels in the short term to curb inflation, only to lower them later when the economy starts to slow down excessively or to decline.

 

"On 3 May, the Fed raised the cost of money by 25 basis points to 5% - 5.25%, the highest level since June 2006," continues Negri, "it is the tenth increase in the last 14 months for a total of 500 basis points. The main central banks are continuing to tighten monetary policy, even though the first signs of easing are beginning to be seen: although we cannot rule out further hikes by the Fed, the likelihood of this happening is less than in the recent past".

We are therefore faced with a complex scenario in which various factors seem to be pulling in opposite directions. On one hand, there is the banking crisis, high interest rates and the inversion of the yield curve, all of which point to a coming recession. On the other hand, however, low unemployment, resilient inflation and slightly improving manufacturing indices seem to be a sign that the economy is still tonic. Against this backdrop of uncertainty, a question arises: how should investors behave?

"A prudent and neutral approach should be adopted on the equity component with respect to the investor's risk appetite," says the head of Banca Generali's Quantitative Management and Unit Linked, "while the bond component should be overweighted in portfolios, especially short-term durations with particular reference to government bonds in the 1-3 year range". With regard to the long-term component, which is more subject to the risk of longer-lasting inflation than expected, according to Banca Generali's manager, it is considered more appropriate to focus on markets where the curve is not inverted (such as the domestic one), thus taking advantage of volatility phases in order to accumulate returns that can form a good portfolio base (levels that were unthinkable in the middle of last year).