Are we facing a 'double dip' recession?

We ask industry experts.... Are we heading for a double-dip recession?

Simon Brett, head of investments, Parmenion
A couple of years ago, governments and their central banks averted a financial crisis from becoming a depression. Record-low interest rates and quantitative easing were used to pump economies with money. GDP growth in the UK turned positive and officially came out of recession. However, recent bad news has led to fears of a “double-dip” recession.

There are two related arguments for a double-dip recession. First, the high levels of Greek debt with talk of sovereign default highlighted the weaknesses of a common currency across disparate nations.

Second, the high debt levels within many European countries have led many to introduce austerity programmes, cutting spending and raising taxes. Electorates have unsurprisingly not greeted such actions with much enthusiasm.

The recent Budget in the UK illustrates how the above has led to fears of another slowdown in the economy.

Post the Budget, the Office of Budget Responsibility (OBR) forecast 600,000 job losses in the public sector, which will hopefully be offset by a recovering private sector. However people losing their jobs plus rising taxes may reduce demand in the economy. Combined with a weakening eurozone area (the major export region for the UK) as other governments pursue similar policies, it begs the question: will the private sector employ more when faced with falling home and export demand? Such a scenario may result in the economy slipping back into recession.

The above gloomy forecast may be proved wrong by continued growth in emerging markets. The IMF forecast overall world growth to be over 4% in 2010, led by 6% growth in emerging markets. Without the scale of the debt problems of the developed world, emerging markets may provide the necessary demand to stave off any slowdown and avoid a double-dip in the developed world.

Stuart Thomson, chief economist, Ignis Investment Management
A double-dip global recession is likely, but not inevitable.  Global leading indicators have peaked and are disturbingly reminiscent of 2002. The US provides the most obvious evidence of this peak, with regional business sentiment indicators, consumer confidence and the weekly ECRI leading indicator all highlighting the likelihood of a sharp slowdown over the next 12 months.

However, other countries are also showing evidence that growth has peaked. UK consumer confidence has fallen for four successive months as consumers react to headlines of severe fiscal austerity. Fiscal austerity in peripheral European economies has also dampened sentiment and activity indicators. 

In 2002, the Fed responded to the peak in global leading indicators and threat of deflation by cutting its funds rate by 50bps in November and a further 25bps in June 2003. This prevented a double dip although domestic demand growth was close to zero. The current environment of near zero official interest rates means any further rate cut will involve quantitative easing to produce negative interest rates.

Agreeing QE in the depth of a recession with concerns over the health of the financial system was relatively easy last March, but will be much more difficult to achieve unanimous support when recoveries are slowing. Regional Fed presidents – Hoenig and Plosser in the US, MPC member Andrew Sentance in the UK, and the Bundesbank in Europe – have all expressed their opposition. But failure to counter fiscal austerity and slower growth will ensure a double-dip.

Trevor Greetham, asset allocation director and manager of Fidelity International’s multi-asset funds
The world economy has recovered from the slump of 2008 but lead indicators are peaking, and as evidence builds things are slowing down, more people will believe the UK is heading for a double-dip. The prospect of substantial spending cuts and tax rises in 2011 can only increase concerns.

Markets are likely to sag for a while and I have been selling equities and commodities in the multi-asset funds I manage, but I am doing so in the hope of buying them back at lower levels later in the year. I have real concerns over some of the economies in the eurozone, but here in the UK, we can devalue our own currency and we can print our own money and this can offset the negative impact of fiscal tightening.

With core inflation adjusted for VAT changes likely to remain low, any signs of slowdown, especially if accompanied by asset price falls, will cause the Bank of England to print more money and the pound to weaken further. Other central banks are also likely to ease policy again. This should set the scene for a re-acceleration of global growth next year.

Peter Hensman, global strategist, Newton
Many commentators now highlight the pace of decline in the weekly economic lead indicator produced by the Economic Cycle Research Institute (ECRI).  The 6% drop in the last six months is typical of the scale of decline that has preceded past recessions.

Yet this need not be a precursor of renewed declines in activity.  Firstly, the ECRI index is more heavily skewed to trends in financial markets than some other lead indicators.  Hence it produced false recession warnings in 1987 and 1998.

Secondly although market conditions have deteriorated and issuance has dried up, unlike 2008 yields are not rising.  The higher spread on risk assets largely reflects the drop in “safe” yields. 

In line with this, US 30-year mortgage rates have fallen to new record lows. Bond yields for the typical Baa-rated US corporate are c5%, nearer the 4.5% low in Q1 2004 than the 7% level in the summer before the Lehman collapse, which then lifted these yields to 10%. In emerging markets, yields are little changed at all-time lows despite the broader market woes.

The example of the Japanese consumption tax hike as evidence of the threat of early fiscal tightening to a fragile recovery ignores the deterioration in the financial sector that continued after the bursting of the Japanese bubble and the tighter monetary stance maintained by the Bank of Japan. Will this prove to be one of the periods that adds credence to the financial saying that “the market has predicted nine of the last six recessions”?

Sam Liddle, fund manager, CF Miton Global Growth – GBP, and CF Miton Global Income
Whether we achieve a double-dip recession or not, financial markets clearly believe that is where we are heading and are acting accordingly in anticipation. In the UK, gilt yields have fallen from 4.1% at the beginning of the year to 3.4% today, with a similar move in US treasuries. Fears of inflation have given way to fears of deflation. If Western governments implement savage cuts in public spending, unemployment will rise, the tax take will fall despite tax increases and economic growth will falter with a consequent downturn in earnings expectations for stocks and a widening of credit spreads in corporate debt markets.

There is plenty of data to suggest a double-dip recession is a distinct possibility; the US has taken no action to address the $2trn annual requirement to fund public spending despite warnings from credit rating agencies US debt could be downgraded. Although that would be ruinous, President Obama seems reluctant to give up on a second term in office by implementing cuts leading to higher unemployment.

Banks seem willing to lend but there is no demand for credit. Low interest rates indicate a lack of demand growth and strong corporate balance sheets imply a lack of confidence and unwillingness to put capital at risk.

Despite this, valuations in many sectors look attractive and when investor focus moves to fundamentals from political interference and a knee-jerk reaction to every release of economic data, the equity of large cap, global franchises with strong balance sheets and a dependable dividend will look attractive again.

Tim Drayson, economic strategist, Legal & General Investment Management
The UK economy has been dragged from recession during the past six months by an extraordinary domestic and global policy response. While growth has resumed, the recovery remains lacklustre. We do not anticipate a double-dip recession as inventories are lean and there is scope for some improvement in investment and exports from depressed levels. But a lack of household income should curb consumer spending, leading to growth of only around 1.5% this year.

With the UK about to embark upon the biggest cumulative fiscal policy tightening potentially seen since World War II, both official forecasts and our GDP estimates for 2011 remain modest.

The OBR recently revised down its growth forecast in 2011 as a result of the spending cuts and tax hikes announced in the Budget. Unfortunately, the OBR’s forecast still looks too optimistic as it assumes one of the largest private sector booms since the deregulation days of the late 1980s. While average market expectations for economic growth in 2011 remain above 2%, we anticipate GDP nearer 1.5%. As a result, we retain the view the Bank of England will keep official interest rates on hold throughout both 2010 and 2011. 

Alec Letchfield, chief investment officer, HSBC Global Asset Management UK Private Client
We believe it is unlikely the UK will endure a double-dip recession.

There are clearly a number of challenges to be faced, and while we do not expect growth to be robust, generally UK plc has so far managed itself efficiently.

Firms have been getting back on track via an abundance of cost-cutting and now many are investing again. And sterling weakness should give a boost to exporters.

But the various fiscal packages, notably the proposed cuts in government spending and the increase in taxes are weighing on growth. The issues impacting upon peripheral Europe are also adding pressure.

Chinese growth is slowing as a result of its government’s intervention. Investors are worried but the strategy is being carried out in a controlled manner and the resulting growth should be sufficient to keep the Chinese engine moving upwards.

Even if things did take a turn for the worse, we do not feel the market would fall back to its recent low, where in March 2009, the FTSE 100 hit 3512.

Even though the index dropped back below the 5,000 mark last week we feel it still could potentially return to circa the 5,600 level by the end of 2010.

Valuations in the market are low by historic levels. The UK is some 10.5 times 2010 earnings but the 15 year average forward PE is 15.5 (based on 12-month earnings expectations). It is our view that recovery is coming through at an economic level, even if it is not as strong as it has been on previous occasions.

Douglas Roberts, senior international economist, Standard Life Investments

There has recently been a rash of double-dip fever following the release of economic data that suggests a growing reduction in the momentum of the global economic recovery. This belief has been bolstered by some high profile research reports, including the ECRI weekly leading index and the US Monetary Policy Forum’s Financial Conditions Index, both of which seem to be consistent with a sharp economic contraction. So, is the global economy really heading for a double dip recession?

Crucially, we must be quite clear what is meant by double-dip, whether we are talking about a return to recession, or merely a sharp loss of momentum. The latter was always highly likely when the impact of the various fiscal stimulus measures began to fade, and when companies had re-established satisfactory levels of inventory. To argue that this slowdown will develop into a full-blown recession with attendant deflationary risks is a leap of faith rather than an economic likelihood, at present. Indeed, the ECRI do not, as yet, regard their leading index as pointing to a probable recession.

The global economy may not be back to full health, but it is less vulnerable to a renewed economic shock. The corporate sector is financially sound, the financial system is less exposed and the consumer has reduced debt levels. Even in the face of a more austere fiscal environment, accommodative monetary policy should help to maintain positive, if sub-par, rates of economic expansion.

Michael Story, product specialist, Western Asset Management
Those who forecast a double-dip often invoke the US experience in the early 1980s. This is an invalid inference. The Volcker Fed engineered the second recession in order to break the cycle of inflationary expectations that had solidified during the preceding decade. In contrast, monetary authorities today are engaged in unprecedented reflationary policies in an effort to stimulate growth.

Recession is a temporary condition while the economy recalibrates toward a new equilibrium. Equilibrium growth today is likely slower than in the past given constrained bank lending, damaged productive capacity and possibly an anaemic labour market recovery. So GDP growth should slow meaningfully in the next six months as the inventory restocking cycle concludes and fiscal stimulus fades. However, it will require a second shock to induce a second recession.

Candidate shocks include a second banking panic and premature fiscal consolidation. The banking panic of 2008 was foremost a liquidity crisis. In contrast, today’s financial system is flush with central bank liquidity, benefits from government guarantees on liabilities and has access to unlimited dollars via official currency swap lines. More than $1.5 trn of capital has been injected into the global banking system. The pendulum has recently swung in favour of those who advocate an accelerated pace of fiscal consolidation. Limiting fiscal deficits may be damaging for peripheral European economies that are locked in an inappropriate monetary union. But the majority of economies benefit from an independent monetary authority fully empowered to cushion the blow of deficit reduction.

Ramon Pons, Matrix Asset Management
The European sovereign and banking crisis will push prices of risky asset down into a double dip during the second half of 2010 but, we will not enter into a double dip recession as real GDP growth for 2010 and 2011 is expected to be positive.

Equities, bonds, property and European sovereign debt will probably fall for the rest of 2010 as risk aversion increases. However, a recession is defined as two or more consecutive quarters of decline in real GDP. UK growth in 2011 is expected to be between 1% and 2%. The US and Emerging Markets will have real GDP growth exceeding 3% in 2010 and 2011.

Euroland has the highest risk of entering a double dip recession as GDP growth for 2011 is forecasted to be just 1%. The key risk for Europe is that the banking crisis could get out of control.

Major economies are recovering, the problem is that they are not recovering as fast as investors would like to. We are facing some years of low real growth with limited job creation. We are at the first stage of a slow recovery. Going forward, investors should have realistic return targets.

The next 12 months are going to be volatile. Going forward, credit should outperform equities but, investors should avoid long only strategies such as traditional long-only bond funds. We recommend investing in market neutral strategies such as long/short credit, relative value, distressed credit and event driven strategies.

Stuart Martin, co-manager, First State Global Property Securities fund

A double dip in the property market is not our base case scenario but we are aware of the risks and the portfolio is tilted to a defensive position.

If we do see a double dip in the property market, it would likely to be led by prevailing economic conditions globally, with any deterioration having the potential to result in further liquidity issues, similar to those that blighted the market in 2008.  That said, a majority of the quoted property companies globally have recapitalised and strengthened their balance sheets since then. Therefore, we believe property shares should show a greater level of resilience, with more headroom to cope with asset value declines.

The real estate market has rebounded strongly over the past nine months and we anticipate that it may retrace some of its recent gains, particularly as valuers are set to grow increasingly cautious in light of the weaker economic outlook.  Moreover, banks remain affected by their exposure to underperforming real estate loans and looming expiry profile and are therefore unlikely to provide a ready source of debt funding for property companies to facilitate the kind of aggressive acquisition drive that was seen in 2006-2008. On this basis, transaction and liquidity in the property markets are likely to remain subdued and valuations more stable.

This would mean that we are likely to see a return to a real estate market more focused on equity driven returns rather than high risk leverage plays, with a subsequent reduction in the level of volatility witnessed in recent times.  As cashflow and yield become more important for REITs, we should see them focus more on extracting long term value by growing income and resulting in capital appreciation, rather than on capital appreciation by yield compression.  A less focus on the quick fix capital junkie approach feeding off a capital gorged market can only be good for the real estate market.  We believe that lower growth, more stability, focus on income and greater certainty in returns is the real estate mantra of the future.
 
Gary Reynolds, director & chief investment officer, Courtiers
Human beings have a tendency to put greater weight on recent events when making decisions.  So, having just experienced a recession, we are mindful of the effects and wary at the prospects for a second.  And having just been “bitten” by an unpleasant situation (the “snake bite” effect), we are doubly-wary of a second.

The good news is that double-dip recessions happen very rarely and there is a sound economic explanation for this.  The “accelerator/multiplier” effect tends to drive an economy in the same direction.  When business anticipates an increase in demand it invests in new capital and employs more people.  This is a double-whammy.  The suppliers of the capital items get the benefit of new orders and so they, in turn, employ extra people.   The overall effect is more people working, more money circulating through the economy and an overall increase in demand for goods and services.

Of course, the multiplier/accelerator effect works in both directions, and this is why quarterly business investment in the UK was slashed from £37.17 bn in June 2008 to £26.98 bn in December 2009.  A cut of 27.39%.  But there is good news.  Investment expenditure in Q1 2010 increased by nearly 8%.

Where double-dip recessions occur, they are normally through policy errors, such as  implementing monetary and fiscal tightening at the same time (the early 1930s).  The cuts that are likely to be imposed by the coalition in the next few years will make the public sector more competitive, and that will be good for the economy.  This is in stark contrast to other places around the world, such as Germany, where crass policy decisions are likely to make a double-dip recession more likely.  But that is another story!

Lothar Mentel, chief investment officer, Octopus Investments
Different from 2008, equity markets are currently trading on very thin volumes, i.e. the negative sentiment is not carried by a majority of market participants. Those still trading currently react so erratically to bad as well as good news from the real economy that one could be forgiven for concluding that equity markets appear to have slightly lost their nerve after the roller coaster ride of the past two and a half years.

Interestingly, bond investors seem to disagree with the equity market sentiment. Here, corporate credit spreads have tightened not widened, and the yield curve itself remains relatively steep rather than flattening.  This is the opposite of what one would expect if the economic environment was indeed deteriorating. This suggests that bond market participants are still expecting a gradual recovery rather than a double dip.

Our stance at Octopus is that while there is a possibility for a double dip, this is not the most likely scenario and it is far too early to make this call on the back of the most recent macro data. We are currently experiencing a quite normal cyclical ‘soft patch’, which is regularly observed once a steep recovery after a severe recession turns into gradual economic growth.

This transition phase has only just started and so for us, further macro data over the next weeks will be crucial in deciding whether our central scenario of a sustained yet anaemic recovery is still intact, or whether the odds for a double dip are really increasing.

In the meantime we are happy to take our lead from the bond rather than the equity market sentiment on the basis that the more fundamentally driven bond market investors have, over recent years, been better at predicting what lies ahead than the marginal investors in equities who of late displayed much more of a short term trading focus than a rational valuation approach.

Mark Harris, multi-manager, Henderson
The world earnings revisions ratio (analyst upgrades to earnings forecasts minus downgrades divided by the total number of estimates) turned negative in June for the first time since July last year, just when other key business surveys, such as the ECRI Weekly Leading Index, showed signs of weakness. Such signs can, however, be misleading and despite the rather unusual backdrop there’s a strong case to argue that such a slowdown is to be expected at this stage in the recovery process.

As my Henderson colleague Simon Ward recently noted on his ‘money moves markets’ blog a loss of growth momentum is not necessarily a precursor to recession. He suggests that it is normal for output momentum to moderate and surveys to soften about a year into an economic recovery. This slowdown phase occurs when the initial boost from the stocks cycle fades and lasts on average about six months before entering into a period of renewed acceleration.

New orders data from the US Institute for Supply Management (ISM) in the chart below appears to reinforce the suggestion that we are on a normalised five-year path. One could therefore argue that the current slowdown represents a ‘pause to refresh’, as the initial boost from the stock cycle fades, rather than the foreshadowing of a double dip. We cannot completely rule out a return to recession but anecdotal evidence suggests that the inventory restocking cycle has now turned the corner into firm new orders, which should be a strong driver for economic growth and ultimately feed through into equity valuations.

Shona Dobbie, head of research centre, Alliance Trust
 
We monitor a range of economic variables to assess the likelihood of slowing growth and recession. Currently, these indicators point to a slowdown in global growth over the coming months, but they are not yet indicating recession. Stagnation appears to be the most likely outcome for the global economy as a whole.

Some individual economies do face the risk of falling back into recession, particularly the peripheral economies of Europe, where policy makers have been forced to introduce austere fiscal policy, but where membership of the eurozone reduces the flexibility of monetary and exchange rate policy. Tough fiscal policy has also been announced in the UK, but we will not be able to assess the full impact of this until the autumn, when we get the necessary detail about the scale and breadth of the spending cuts.

Although we are currently expecting a period of stagnation in the global economy, we are concerned about weakness in the US labour and housing markets, the risk that attempts by Chinese policy makers to cool property speculation may damage the rest of the economy, and potential contagion from the sovereign debt crisis in Europe. The outlook for growth over the next year is going to be challenging at best and our concerns about recession will increase sharply if we see a significant decline in business confidence, implying an even weaker outlook for both investment and employment, or signs that Chinese authorities are loosing control of their ‘managed’ slowdown.

James Dowey, chief economist, Neptune Investment Management
Our outlook is that the major developed economies will grow over the next couple of years – but slowly. This is what tends to happen when recovering from a banking crisis because lending and borrowing are slow to recover.

In these weak conditions there is a natural vulnerability to a double dip recession. But incidents of ‘double-dipping’ from the past, such as in the United States during the early 1980s, show us that a second, distinct ‘punch to the solar plexus’ is required to actually make it happen.

As we scan the global economy today we see the risks of overly aggressive tightening of fiscal policy – particularly if everyone does it at the same time; though a premature tightening of monetary policy does not now seem to be on the cards. Governments are almost certain not to get it right – and this could quite plausibly tip growth into negative territory again for the odd quarter.

But if we are talking meaningfully about a serious derailment within the next 6 months to a year, reminiscent of 2008, with a deep impact on wealth, this would require a much bigger negative impetus – and this is not our central view. On the contrary, we point to the strong growth in emerging economies, representing well over half of global growth at present, as a positive impetus for certain asset prices.

John Velis, head of capital markets research EMEA, Russell Investments
While we don’t believe a double dip recession as likely, we do acknowledge that a “growth scare” is entirely possible. The current recovery will be marked by a much more lacklustre rate of economic growth due to ongoing deleveraging in the private sector, very slow labour market activity and the expiration of the government stimuli around the world.

These factors could conspire to make a muted recovery look very tenuous to investors, and indeed bring about market fears of a double dip. Barring a significant shock, however, we don’t think such fears will ultimately prove to be reality, even though while the market wrestles with this uncertainty it will certainly feel like the odds of a double dip are increasing.

There is of course significant political risk, especially the ongoing uncertainty around European banks and the fiscal position of many members of the eurozone. Should these problems translate into significant shocks to the economy and the markets, then a double dip becomes more likely. However, we think that in the short term markets and economies will muddle through. Instead, a weak but positive economic scenario seems most likely.