In spite of the trauma of 2007 to 2009, the reality is that US recessions have been tending to become less frequent and milder over the last few decades. Of the 33 US recessions that have occurred since 1854, 21 (64 per cent) occurred before World War Two and only 12 (36 per cent) have occurred since.
::Recession characteristics
For investors, remembering that recessions have historically been much shallower than expansions provides essential context. In a typical post-war recession, GDP has fallen by around 2 per cent. Conversely, expansions have tended to add around 20 per cent to output. This means that the economy is generally more likely to grow than not – the forces of innovation and how they interact with the learning curve remain formidable and generally more resilient than widely imagined. It is these same forces that drive continuing growth in global output and, importantly for investors, corporate profits. The threshold for betting against these forces – against mankind in a sense – is generally much greater than the popular caricature, which tends to portray the world economy as a debt-inflated accident waiting to happen.
::Triggers
While long-term investors should be reassured by this historically reliable growth trend, those trying to trade the vagaries of the business cycle obviously have a harder job. The fact is that the causes of recessions are many, varied and often still mysterious.
For their part, the International Monetary Fund (IMF) has identified several key contributors to recessions across advanced economies since 1960, with oil shocks and excessive monetary policy tightening the most common culprits historically. The IMF’s taxonomy however, was only able to identify triggers for half of their sampled recessions – with the remaining half caused by idiosyncratic shocks like investment swings due to ‘animal spirits’ or asset price collapses.
::‘Gambler’s fallacy’
Contrary to popular belief, the economy is not a clock that undergoes boom-and-bust cycles with deterministic regularity. This concept of a ‘clockwork economy’ may fit certain triggers like a financial crisis – where bouts of speculative euphoria eventually sow the seeds of turmoil – but it doesn’t for other recession triggers.
Claiming that the economy is overdue for a recession solely because we are past the average business cycle length, is essentially the ‘Gambler’s fallacy’ in action. It is as wrong as claiming that the next coin toss is more likely to come up heads, just because the preceding ten tosses yielded tails. Economic expansions do not die of old age.
::Investment conclusion
It is difficult to call recessions. There are a huge range of triggers, many of which are impossible to predict and some that are still being debated. This may not sound reassuring for investors still scarred by the last recession and the Global Financial Crisis. However, knowing what we don’t know is helpful here, as it allows us to tune out the many siren voices that would lure us away from our optimal investment portfolio. This, and the long-proven fact that the occasional recessions – however deep or painful they may be – have always been outweighed by mankind’s inexhaustible ability to innovate and grow, provide the most helpful context for longer term investors. The fact that the world economy is close to a third larger in real terms, over 20% on a per capita basis than it was at its last peak in 2007, pays testament to this idea.
We believe it is important to be aware of how uncertain many recession indicators are and focus on those with a slightly stronger track record, such as the ISM Manufacturing Index and the yield curve. Right now these indicators suggest that a US (and therefore global) recession is not imminent.The prospects for ongoing growth and inflation beating investor returns remain reliably founded on mankind’s continuing ingenuity and restlessness.
Jonathan Sloan (jonathan.sloan@barclays.com) is a private banker at Barclays Wealth & Investment Management
