Valentijn van Nieuwenhuijzen
Financial markets have over-estimated the chances of a global recession. Equity and high yield markets have factored in probabilities of 50% and 75% respectively, but we believe it is difficult to say the likelihood of a recession is any more than 20%.
Developed market growth momentum fell back somewhat to around a 1%-annualised pace during the second half of last year, but neither the level of growth nor the degree of the fall-back looked alarming from an historical perspective. It falls easily within the range of movement in the business cycle that can be described as noise rather than clear change of direction.
Equity valuations have come down by up to 20% from the recent highs, implying an increased risk of an earnings recession. We doubt this will happen outside the commodity sectors as the consumer sector is supported by low oil, low interest rates and an improving labour market.
We also see little earnings risk for the health care sector. In addition, central bank support will help market sentiment. For all these elements we maintain a neutral stance, instead of throwing in the towel and follow the herd over the cliff.
Nothing guarantees that data surprises will not weaken further but the facts on the ground are certainly not yet aligned with a base-case recession scenario.
The levels of risk premia, that are now available illustrate the impressive extent of recent market moves: the equity risk premium is currently around 5% compared to a long-term average of 3.5%. It has only ever been higher in the last 25 years during the peaks of the credit and Euro crises in 2008 and 2012/13.
Also, the spreads at which high yield bonds trade over government bonds have only been higher in crises periods including the savings & loans and LTCM crises of 1991 and 1998; accountancy scandals in 2002/03; and the credit and euro crises.
Valentijn van Nieuwenhuijzen is head of multi asset at NN Investment Partners
