The current economic cycle seems to be on course to beat longevity records. This is worrying investors, who think that the days are numbered for this unusual ‘Goldilocks’ environment (not too hot, not too cold) and that we are perhaps headed for a slump.
The key to understanding where we now stand lies in focusing on what caused the last recession in 2008 – an anomaly in the history of recessions, as it saw capital injection from the world’s central banks and ultra-low interest rates.
Normally, a recession means central banks raise interest rates to stem the excesses of an overheating economy. It was a financial crisis of the kind we read about in history books – those that happened before WWII and government intervention and where economic cycles were extremely long, lasting a generation and taking 20-25 years to recover. This cycle is longer than other post-WWII cycles due to the following unusual characteristics:
– After the Lehman Brothers bankruptcy in 2008, everything stopped at once: industrial activity, corporate investment, consumer spending and credit flows; businesses and individuals alike were staring into the abyss, leaving a lasting mark on them as economic agents
– The reaction by central banks increased the feeling of panic, as they resorted to policies which had not been used in living memory
– Because the crisis was sparked by something people didn’t even know existed (subprime mortgages), it heightened worries about other, equally unexpected crises in the future.
No wonder the recovery was so patchy and slow. Companies and banks deleveraged for years, consumers continued saving as if the recession was still on, and investors did not trust the stability of the market, being reluctant to take risks as they had in previous cycles.
The net result was slow growth, low inflation and lagging standards of living. Although unemployment has fallen to very low levels in the US, Japan, the UK and Germany, it hasn’t led to wage inflation, causing many economists to reassess the standard relationship between prices and joblessness. The Federal Reserve Bank (Fed) was the first central bank to raise interest rates, to ‘normalise’ monetary policy (as if the cycle had been normal). Other developed central banks are still sitting on the sidelines, watching the Fed before committing to policy changes. That’s why this economic cycle is continuing – but when will it end?
Our US-based Canaccord manager, Tony Dwyer, recently visited our shores and delivered a simple message: the US is not about to go into a recession. None of the conditions of a recession are present (inverted yield curve, high real rates, market stress). If, against all odds, President Trump can deliver a massive fiscal stimulus (tax changes, deregulation and infrastructure spending), inflation could soar and foreshorten the economic cycle – if not, we still have some room ahead.