19 Oct 2023 4 min read

Let's do the time warp again

By Emiel van den Heiligenberg

Despite the warning lights flashing red, the recession still hasn't arrived. But that doesn't mean we're out of the woods - this all feels eerily familiar.


The following is an extract from our Q4 Asset Allocation outlook.

Our outlook remains that this cycle will end in recession and risk assets will underperform going forward. We’ve been wrong on the timing, however, and now expect the US recession to land in the first half of 2024.

This is a frustrating position to be in, but the thing we are focused on is whether we can remain confident in the end game: that a slowdown will ultimately unfold into a recession. We believe we’re right to go against the crowd.

Rose tint my world

Although global equity markets are now around 5% off their peak1, we don’t think this move is about the market sharing our US recession fears. Instead, we think this has been driven by a rise in real rates and widespread belief that China will go through a long period of low growth and elevated credit risk.

Indeed, US growth estimates for the third quarter have been moving higher on the back of benign inflation prints in June and July and signs of a gradual loosening of the labour market. Combined with robust growth earlier in the year from higher fiscal and infrastructure spending, excitement is building about the health of the US economy, yet we think some of the positive news on growth and inflation is temporary.

Quite a bit of the inflation improvement has been erratic, making it difficult to discern a solid trend. Wage growth, meanwhile, remains too high for inflation to be consistent with central bank policy, and if we get wage growth without inflation you get a margin squeeze.


The Sword of Damocles

The biggest driver of our recession view is the lagged impact from tighter monetary policy. Ongoing Federal Reserve (Fed) quantitative tightening should influence bank lending behaviour as pressure on their deposit base builds. Given that we’ve been wrong on our recession call for several quarters now, what would it take for us to abandon the view?

  1. Wages falling while unemployment remains low: not much news in recent weeks on this front
  2. The trend in bankruptcies/ delinquencies reversing: we still see a weakening trend
  3. Bank lending picking up: again, we still see a weakening trend
  4. Europe improving: European PMIs have been very weak in recent weeks
  5. House price transactions increasing and prices not falling: limited evidence so far

We’ve seen this horror show before

History also gives us some comfort in our contrarian call, showing that the ship can sometimes sail on while the hull fills with water.

There are parallels with the year 2000, when the Fed felt comfortable holding rates in restrictive territory through the summer and autumn, only to be surprised by the extent to which the economy slowed. This triggered an emergency rate cut in January 2001. But with inflation more of a constraint today, we believe it will take greater economic weakness for the Fed to suddenly reverse course.

2007 and early 2008 also provide a salutary reminder that it’s wrong to believe nothing bad will happen just because nothing bad has happened yet. The S&P rallied 20% in 2006 and 2007, peaking just eight weeks before the global financial crisis started. Real GDP in the second half of 2007 increased at an annual rate of 2.5%.

In January 2008, the Fed did not forecast a recession. The collapse of a pair of Bear Stearns hedge funds with heavy exposure to assets such as the now infamous collateralised debt obligations (CDOs) went unnoticed by many as a signal of the crisis to come.

How we’re positioned

We expect risk assets to underperform over the medium term, and therefore have a negative outlook for equities. We prefer defensive equity sectors over cyclicals and have a positive view on infrastructure.

In line with our pessimistic outlook for economic growth, we are positive on government bonds, particularly UK gilts. We believe exposure to sovereign bonds could be beneficial should significant signs of economic weakness emerge. We also favour US inflation-linked bonds and consider current real yields to be unsustainable over the medium term.

We are underweight corporate credit and have a modest negative view on sterling.

The above is an extract from our Q4 Asset Allocation outlook.


1. Source: Bloomberg as at 22 September 2023.

Emiel van den Heiligenberg

Head of Asset Allocation

Emiel is responsible for the overall strategic direction of the team’s investment and business strategy. He claims to have been a promising lightweight rower at university until French fries got the better of him. Reflecting his love for rowing in a team, he firmly believes that excellence can only be achieved by a great team made up of motivated individuals that are also eager to work together. To this end he is the self-proclaimed inventor of the verb 'teaming' to acknowledge that shaping a top team and culture of excellence is an ongoing process. Outside of work-family obligations, Emiel’s spare time is filled by a passion for shark diving and skiing. Prior to dedicating his career to portfolio management in 1996, Emiel worked as a policy adviser in the Dutch Ministry of Finance and he graduated from Tilburg University in the Netherlands ages ago. When not glued to his Bloomberg screens, this Dutch man is hooked on computer games, peanut butter and his favourite dark beer made by Belgian monks.

Emiel van den Heiligenberg