Manulife: Recessions are More than Just a Number: An Investment Framework

In a recent press release from Manulife IM, Frances Donald, Global Chief Economist and Strategist at Manulife Investment Management, highlighted the potential of an upcoming U.S. recession. The brief emphasized the importance of investor awareness in these uncertain economic times and succinctly presented five key considerations, aiming to guide strategic decision-making amidst market volatility. This initiative reflects Manulife IM's dedication to providing investors with crucial, timely insights in a rapidly changing global economy.

Despite increasing hopes for a soft landing, they maintain the perspective that the U.S. economy will enter a mild to moderate recession in the next six months. They anticipate two consecutive quarters of negative GDP growth, coupled with an uptick in the unemployment rate.

While initial instincts may categorize this as unequivocally negative for investors, it's worth exploring if this reaction is truly justified, or if it stems from a conditioned response to perceive economic situations in binary terms: growth (positive) versus recession (negative). They argue that for long-term investors, this simplistic “recession or no recession?” mindset is not only unproductive but could also obstruct potential investment gains. A more nuanced approach is essential.

They predict that in the upcoming months, the dominant market sentiment will acknowledge the likelihood of a U.S. recession. When this term reenters mainstream discussion, investors will need to evaluate the pessimistic predictions, considering five fundamental aspects that they argue have more significant investment consequences than mere GDP projections.

1. Prioritize momentum over recession classifications.

The question of whether economic activity retracts sufficiently to meet the formal recession criteria is less critical than the impending reduction in growth momentum. They argue that lending, consumer activity, capital investment, and earnings are set to decline over the next six months. These factors will likely hold more importance for investors than the retrospective calculation of economic performance. Even if the economy avoids a technical recession, the minimal difference between a slight contraction and marginal growth will have negligible importance to investors. They believe that even the more optimistic scenario will pose a challenging atmosphere for risk assets.

2. Keep track of elements that might shape the forthcoming recession.

The nature of any future recession may vary from previous ones. They highlight several reasons why the next recession—assuming it occurs—could be unique, with three aspects particularly prominent:

- Desynchronisation: Current significant discrepancies exist within the U.S. and global economies. Specifically, manufacturing and services sectors are operating on distinct cycles, potentially leading to a recovery in U.S. manufacturing even as services falter. This disparity might create specific opportunities despite a broader economic downturn.

- Labour hoarding: They argue that the existing labour shortage, a structural hurdle, will persist, complicating business operations as recession risks escalate. While this won't preclude higher unemployment, more prevalent labour hoarding could temper the unemployment rate's rise compared to previous recessions.

- Heightened uncertainty: They underscore the current climate of increased geopolitical risks, aggressive inflation driven by supply constraints, and escalating severity of weather-related incidents. These factors are likely to challenge and reshape traditional recession theories.

3. Relative performance in a global context.

For investors, economic performance is often evaluated in relation to regional or global counterparts. A U.S. recession or slowdown undoubtedly complicates domestic investment strategies, but they believe that even in such circumstances, the U.S. may fare better compared to a globally decelerating economy. They predict harsher conditions for other developed nations and emerging markets, burdened by factors like soaring oil prices, diminished Chinese economic growth, and a robust U.S. dollar. Paradoxically, within this framework, a U.S. recession forecast doesn't conflict with the prospect of resilient U.S. risk assets on the world stage, as recently detailed in their Multi-Asset Solutions Team’s asset allocation perspectives.

4. A mild recession versus stagflation.

They believe that encountering a recession soon might not represent the grimmest scenario for investors. A typical recession pattern—declining growth followed by central banks reducing interest rates, culminating in growth resurgence—poses short-term hardships for investors but can offer long-term asset class opportunities. Conversely, a "soft-landing" scenario—where growth diminishes but not drastically—could result in a more formidable investment landscape, marked by stagnation and absent significant economic recovery. They argue that a situation where the economy skirts a recession yet languishes in extended suboptimal growth might present a tougher challenge for investors.

5. Consider the investment timeline.

They emphasize that an investor's timeframe critically influences recession response strategies. While considerable effort is directed at evaluating recession probabilities, equal focus is placed on potential post-recession recovery. They foresee a long-term scenario defined by superior quality growth, moderately increased inflation, and higher interest rates compared to the post-financial crisis era. For asset allocators, this generally implies an optimistic medium to long-term investment horizon.