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Janus Henderson: Prepare for Recession in 2019

London weather has turned cold, is the economy set for the same fate? Economic growth GDP UK
London weather has turned cold, is the economy set for the same fate? Economic growth GDP UK

Economic growth has reached its peak and we are heading for a “significant slowdown in the global economy”, according to Simon Ward, chief economist at Janus Henderson Investors. He predicts there will be a global recession in either 2019 or 2020.

Ward says monetary trends suggest the slowdown in growth will be broadly based – as the current upswing has been – and could begin as soon as next month.

His worry then is that central banks are too focused on inflationary risks, meaning they will be slow to respond to signs of weakening growth. “That could be a dangerous mix for markets,” he says.

There are two reasons for his confidence in predicting this. The first is that “real money” trends lead the economy and second is his analysis of economic and business cycles.

The first point, he explains, shows why we’ll see a slowdown in economic growth this year. Ward says that turning points in real “narrow”, or M1, money growth have led turning points in economic growth by an average of nine months.

His measure of real narrow money growth reached a trough in mid-2015, rising strongly into late 2016. “This signalled that economic growth would be strong in 2017,” he says, which it was. But real money growth has fallen since then.

“The most recent peak occurred in June last year. So, allowing for the average nine-month lead time, that suggests economic growth should be peaking out around now and will slow significantly over the remainder of 2018.”

Ward then uses cycle analysis to weigh up prospects beyond that 12-month horizon. The three key business cycles are the stockbuilding or inventory cycle, which lasts between three to five years; the business investment cycle, which lasts between seven and 11 years; and the housing cycle, which can run for 25 years.

“Recessions typically occur when two or more of these cycles are simultaneously weak. Really big recessions occur when all three cycles hit rock bottom in the same year. That’s what happened in 2009.”

Ward says troughs in the stockbuilding cycle occur on average every three-and-a-third years and the current cycle bottomed out in early 2016, meaning the next trough will be around the middle of 2019.

The business investment cycle, meanwhile, last bottomed out in 2009 by Ward’s calculations. With its maximum length of 11 years, the next trough is due by 2020 at the latest.

While a trough in the housing cycle isn’t scheduled until the mid-2020s, “there is a significant risk that the stockbuilding and business cycles will be simultaneously weak either in 2019 or 2020”. Should that happen, a global recession in one of those years is “a strong possibility”.

Ward admits his view is counter consensus and that the overall outlook remains bullish for economic growth. However, we’ve heard some rumblings of discontent in recent weeks.

David Vickers, multi-asset portfolio manager at Russell Investments, told us the US could enter a recession as soon as 2019, and he believes many economists are beginning to share the view that trouble is looming.

Economic Fundamentals Remain Positive

Bank of America Merrill Lynch analysts point to the slowdown in GDP growth we’ve seen in recent quarters. In the final three months of 2017, the G4’s aggregate growth rate dropped to 2.3%, from 2.9%. BAML predicts that will fall further for Q1 2018, to 2%.

But the analysts remain optimistic. “First, the weakness in the GDP data has been largely due to a confluence of seasonal issues, weather shocks and statistical noise,” they explain. “There should be payback for these distortions in coming quarters, in our view.

“Second, many other measures of activity remain strong; GDP appears to be an outlier. Third, economic fundamentals continue to point to above-trend growth.”

Nick Gartside, co-manager of the JPM Global Bond Opportunities Fund, considers talk of a recession in either 2018 or 2019 to be “premature”. “It’s easy to say there’ll be a recession in 2020, but in reality you’re talking about something that is two years away; who knows what will happen by then.”

Gartside says that central banks tend to cause recessions when they overtighten monetary policy. That’s because households and small businesses tend to default when they can’t afford to refinance their debt at attractive rates.

A good guide to where an interest rate should be is inflation. Take the US, where monetary policy is tightest. Its inflation rate currently stands at 2.2%. The Fed Funds rate is at 1.5%. Four more rate rises this year, which is what Gartside expects, will take rates in line with inflation.

“Typically you would expect interest rates to be around 1-1.5% ahead of inflation, so we’re a million miles away from that now. We’ve certainly not had too much central bank tightening yet.”

Further, the Bank of England has only just put the interest rate back to where it was pre-Brexit vote; The European Central Bank and the Bank of Japan are still easing policy. “That’s not screaming recession,” says Gartside.