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Slowing Economy, Still Growing

Slowing Economy, Still Growing

The global economy is slowing yet still growing and could allow us to avoid a global recession.

My forecast might sound too optimistic given the disappointing equity and GDP performance in the first half of 2022. However, global markets have made up a lot of ground, most economic categories are still in growth mode, and most individual and professional investors can’t fathom a recovery. While a shallow recession is still possible, equities are likely already pricing this in, and thankfully most indicators don’t signal a recession is underway or imminent.

Equities reflected a lot of worries as indexes went into bear market territory earlier this year and likely from the multiple frightening narratives exacerbating investor uncertainty, leaving sentiment extremely grim. Just look at the sheer number of negative headlines at any moment (inflation, oil, China, Taiwan, Monkey Pox, UK/Russia, Federal Reserve rates, lay-offs, etc.), amplifying uncertainty and increasing downside volatility.

Even the Global Fund Manager Survey shows a recession in 2022 is consensus, and fund managers’ cash levels have risen. So if retail and professional investors are overly dour, then all we need is for economics to be slightly better than perception because markets move on the difference between expectations and reality.

Many think the stock market and the economy are in real trouble, if not outright going to hell in a handbasket. This primes the pump for stock markets to have a big rally as concerns fade. For example: in 2019, after equities fell nearly -20% late in 2018, global developed markets were back at breakeven by mid-year. In 1998, equities were negative on the year in October—but a Q4 rally lifted full-year returns to above 20%. Recoveries from market downturns often begin when sentiment becomes excessively dour, setting the stage for an upside surprise.

Yes, equities often fall ahead of economic contractions but can thrive at any level of economic growth. In the past, equities were mostly positive when the US and Canada were in a modest GDP growth environment. So, slow growth is fine for equities—they do not require fast growth to perform well. Slower growth can sustain equity bull markets, but it is likely to favor less economically sensitive firms. Yes, a slowing global economy can pave the road for a future recession, but a significant market downturn from here would likely require a more extensive, lengthy economic downturn, which has not been shown to exist at this time.

Positive economic factors like healthy consumers, businesses, and banks are going largely unnoticed. During the pandemic, consumption patterns shifted from services to goods, straining supply chains, which led to shortages and price spikes. However, consumption is gradually normalizing and moving back to services, easing some of the supply-chain issues that exacerbated the surge in goods’ prices. Companies are healthy and continue to support their share prices by buying back shares at a record pace. Global banks are extremely well capitalized and lending at a healthy rate. Tier 1 capital ratios and other measures of bank balance sheet strength are at the highest levels in history, suggesting the risk of a banking crisis is very low. Inflation is moderating (but still high) and should continue to ease through the rest of 2022, especially now that shipping ports have cleared their massive backlogs. It may also put pressure on central bankers to stop tightening aggressively. Yes, there are some falling business survey readings that show signs of recession, yet most officially registered expansion—slower growth, but nonetheless growth.

Global markets have likely priced in well-known fears, including a mild recession. Slower economic growth and inflation expectations will likely continue to moderate as supply, and labor constraints subside, supporting a recovery in the back half of 2022 because even though parts of the global economy show pockets of weakness (and strength), it is a better reality than the picture painted by increasing numbers of recession forecasts in the media. Such a wide gap between reality and expectations may have created a bear market bottom in June—the exact timing of any recovery is only apparent in hindsight.

Equities can flip from bad years to good very quickly. So, remember, when negativity drives fear and sentiment overshoots to the downside, markets are primed to rebound as uncertainty clears because what matters more are expectations for forward-looking market conditions over the coming 6 to 12 months.

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