23 Feb 2023 3 min read

The triumph of hope over experience

By Emiel van den Heiligenberg

Rising household debt levels and pressure on company margins mean the soft-landing narrative increasingly looks like a fairy tale.


The crucial question for risk asset returns in 2023 is whether we’ll see a recession in the next 12 months or not. Our recession indicators are not improving, and the US Federal Reserve (Fed) continues to raise rates, meaning we still believe there’s a 75% chance of recession by year end.

We agree with last week’s comments from European Central Bank (ECB) board member Isabel Schnabel when discussing the Eurozone:

“Markets are priced for perfection. They assume inflation is going to come down very quickly toward 2% and it is going to stay there, while the economy will do just fine. That would be a very good outcome, but there is a risk that inflation proves to be more persistent than is currently priced by financial markets.”

The US pricing of inflation has adjusted upwards to some extent, and we believe the narrative of soft a landing – low inflation with not too much in the way of a growth correction – remains in place for the US as well.

Mind the household debt

One interesting release which normally garners less attention was the New York Fed quarterly household debt and credit report. This showed household debt accelerating in the fourth quarter, growing by almost 10% annualised. This might have helped fuel the rebound seen last week in January’s US retail sales (notwithstanding some of the seasonal adjustment problems).

The data feed into the broader private sector credit growth contained in next month’s US Financial Accounts and feature in our recession indicators. In our recent update this indicator was one of a few yellows (neutral to mid-cycle) amid a sea of red (watch out – late cycle), but this indicator now looks to be turning red as well.

Strong private sector credit growth can be a sign of late-cycle excess. Another unusual data point is US credit card debt, which grew by 29% annualised in the fourth quarter. That’s the strongest quarterly growth in credit card debt since the data started in 2003.

In this case it suggests the savings buffer accrued during the pandemic is running low and households are turning to other sources of financing to sustain spending. This is happening in an environment where interest rates have risen rapidly, so debt servicing on this new borrowing will quickly become onerous, in our view.

The report also shows a fairly large increase in auto loans and credit card delinquency rates over the last four quarters from the unusually low levels reached after the pandemic. The fact that more borrowers are missing their payments, particularly when economic conditions have been strong, is a worry.

The stress is concentrated in younger borrowers and this cohort disproportionately holds student loans that are currently in forbearance. Once student loan repayments resume later this year, delinquencies could climb further.

A narrowing path

Recent bumper payrolls and last week’s higher-than-expected inflation and retail sales data did little to deter markets from their soft-landing beliefs: disinflation, without a recession. Like the ECB’s Schnabel we believe this belief will be increasingly tested over the coming quarters.

On the one hand inflation might be stickier than expected and the Fed could need to push rates higher for longer. On the other hand, markets seem to believe that earnings can hold up even though prices come down and companies are deliberately slow to cut costs.

We are sceptical.

Top-line growth is likely to come down and this could impact margins. Hoarding labour might make sense in hindsight (it's difficult to find staff) but holding onto labour if growth were to fall means margins are even more impacted. We expect sharply negative earnings per share growth this year.

We are sticking with our ‘short risk’ position. Performance has been flat since our entry position, and we’re inclined to sell more risk if the market rallies from current levels.

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