End-of-cycle anxiety

The current economic expansion in the US is only five months away from being the longest ever recorded. And with unemployment near historic lows, and consumer and business confidence showing great strength, it is difficult to foresee an imminent derailment of the US economy.

However, human minds function largely on the basis of anticipation, and investors have been worried lately about the possibility that the economy will go into recession in 2020; causing a sharp fall in the price of risk assets

There are a number of reasons behind such a grim outlook. The expected fading of the stimulus caused by the tax reform − and the burden generated by the resulting deficit − the end of an era marked by (brazen) support from central banks, concerns about a possible trade war, but also a certain «altitude sickness» caused by the longevity of this cycle.

All these factors indicate that the best is already behind us, and that we are entering a new phase with fewer positive stimuli, in which avoiding a recession will depend on economic agents managing the decline in a responsible manner.

Facing the end of a cycle requires psychological strength. As football fans know well, it’s hard to see your team go from glory to mediocre performance. Decadence is not a linear process. After a good day, there is always the temptation to think that it is still possible to stay on top, only to fall into despair when the team stumbles again.

Consumers, investors and business leaders are experiencing a similar process, since macroeconomic data show mixed signals. Keeping up the economy is a social enterprise, and the temptation to «piggy-back» is large. If economic agents reduce consumption and investment as a result of worsening data, they can aggravate the slowdown and lead the economy into a recession, if on the contrary they remain calm, the current expansion will continue.

This type of end-of-cycle anxiety is aggravated by the fact that the previous two recessions coincided, or rather, were triggered, by the collapse of a stock market bubble, and a once-in-a-century financial crisis. These caused the S&P 500 to fall from its highs by -48% and -58% respectively; forging a generation of traumatized investors for life.

But not all recessions are equal and, for example, during the two «standard» recessions experienced in the 80s and 90s, the stock market fell by only -25%. Taking into account that since the peak of October last year, the S&P already corrected -20%, long-term investors should not be too worried.

Of course, the nature of the next crisis is still unknown; it can be a shallow recession followed by a rapid recovery, but it can also be a depression if, for example, China implodes. In addition, there is great concern about the room for maneuver that policymakers will have when the next crisis finally hits, since fiscal and monetary tools have largely been exhausted.

Time will tell whether we will face a «relief recession,» that helps dissipate accumulated anxiety, or a severe depression. What we do know is that timing recessions is extremely difficult and that sitting in cash waiting for the next one to come can have a large opportunity cost. Therefore, it is advisable to focus on identifying companies with business models that can withstand economic cycles well, instead of trying to guess the future by reading the tea leaves.

Fernando de Frutos, MWM Chief Investment Officer

 

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