abrdn Sees The World On The Brink Of Recession

abrdn Sees The World On The Brink Of Recession
Stéphane Renevier, CFA

about 1 year ago5 mins

  • abrdn’s base case outlook isn’t pretty: its economists think markets are underestimating the potential depth and duration of the coming global recession. They expect growth, inflation, and even interest rates to fall sharply in 2023.

  • For the economy to end up better than their base case, they say supply chain and labor market issues must be resolved, or inflation must become more sensitive to a slowdown in growth.

  • Things could get even worse, however: core inflation could become a lot stickier than expected, or a price spike in commodities could bring inflation even higher, forcing the Fed to keep hiking rates aggressively until the economy falls into a profound recession.

abrdn’s base case outlook isn’t pretty: its economists think markets are underestimating the potential depth and duration of the coming global recession. They expect growth, inflation, and even interest rates to fall sharply in 2023.

For the economy to end up better than their base case, they say supply chain and labor market issues must be resolved, or inflation must become more sensitive to a slowdown in growth.

Things could get even worse, however: core inflation could become a lot stickier than expected, or a price spike in commodities could bring inflation even higher, forcing the Fed to keep hiking rates aggressively until the economy falls into a profound recession.

Economists at abrdn see the global economy on the precipice of recession – and say the investing world might not be ready for it. Here’s their base-case forecast, two outcomes they view as less likely, and the assets you may want to consider for each.

What’s the base case then?

Growth: It’s not pretty: economists at the Scottish-based asset management firm (and parent company to Finimize) expect the global economy to fall into a deep and prolonged recession in 2023. They say aggressive interest rate hikes, Europe’s energy crisis, and weaknesses in China will ultimately push the global economy over the edge. And they’re warning that the market’s consensus of economists is underestimating the potential depth and severity of the global slowdown.

Inflation: Their research shows that global inflation has already peaked, or is about to. They see global inflation falling to 6.3% by the end of 2023 (and US inflation halved to 4.1%) by the end of 2023, as lingering supply chain issues ease, commodity prices come off their highs, and the economy slows. The recession is also likely to significantly bring down core inflation (the measure that excludes the more volatile food and energy prices), but because of how strong the labor market is, it might not happen as fast as the consensus expects.

Interest rates: The economists expect the Federal Reserve (the Fed) to raise interest rates by another full percentage point by the end of the first quarter, with rates peaking at over 4.75%. But, as indicators begin to reveal a weakened economy, they see the Fed pausing for a few months, before ultimately cutting interest rates in the second half of the year as the global recession bites, damaging the US job market. The economists say the consensus is currently underestimating the speed and extent of these eventual rate cuts.

A deep global recession will force central banks to cut rates aggressively. Source: abrdn
A deep global recession will force central banks to cut rates aggressively. Source: abrdn

Europe – and the UK – are likely to be first to enter a recession (if they haven’t already) with consumers facing unprecedented cost-of-living challenges. The US should follow in the second quarter of 2023, or potentially even in the third given the current vitality of its consumers and labor market. abrdn’s economists aren’t upbeat about China: they say investors are in for a disappointment when it comes to the removal of zero-Covid policies and easing measures in the property sector. As for the rest of the emerging market economies, they’re doubtful that their central banks will be able to do enough to offset the slower domestic growth, more challenging financing backdrop, and domestic imbalances that lie ahead.

What’s this mean for your portfolio?

If you agree with abrdn’s base-case projection, you could consider investing in Treasury bonds, because they’re likely to benefit as growth, interest rates, and inflation all fall. Gold should also do well in this environment, particularly if inflation doesn’t drop all the way to its previous low levels. You might want to consider an underweight stocks position (i.e. a lower exposure than you’d normally have): corporate earnings are likely to take a big hit in a deep recession, especially since investors have remained quite optimistic on their earnings outlook. As for which stocks you should own, you might want to favor quality companies in defensive sectors like consumer staples, utilities, or healthcare, which might prove more resilient than the broader market in a downturn. I shared a few tips on how to find those stocks here.

Does abrdn have a rosier scenario?

It does. With so many uncertainties and moving pieces, identifying other possible scenarios is arguably as important as focusing on the base case. Abrdn’s economists came up with eight alternative scenarios, four of which (green circles) involve growth and inflation being higher than in the base case.

abrdn's alternative scenarios, relative to base case scenario. Source: abrdn
abrdn's alternative scenarios, relative to base case scenario. Source: abrdn

To achieve those sunnier scenarios, abrdn’s economists say you’d most likely need to see either a significant recovery on the supply side (15% probability), or inflation that’s very sensitive to the slightest downturn in the economy (17.5%). In the first case, an improvement in supply chain issues, energy markets, and the labor market could mean that inflation would fall by itself, even if growth remains high. This is arguably the sun-shiniest possible outcome, with growth ending up very positive and inflation falling at least closer to normal levels. The second case is the so-called soft-landing outcome, in which the Fed’s rate hikes slow the economy just enough to tame inflation, but not enough to cause a recession. In this outcome, growth and inflation are both higher than in the base case.

If a rosier scenario plays out, global stocks, small-cap stocks, and value stocks are likely to do well. I shared a few more detailed ideas here.

Does abrdn have a gloomier scenario as well?

The base case is by no means cheerful, but abrdn’s economists say two potential factors could result in an even bleaker outcome. The first is if core inflation becomes more sticky than expected (probability: 17.5%) – that could lead the Fed to continue aggressively raising interest rates, even as the economy slows down. The economists believe this gloomy scenario is as likely as a soft landing. The second is if commodity prices see a sharp spike (probability 10%), maybe caused by weather events, geopolitical developments, poor policy, or stronger demand that initially brings inflation to an even higher level. If those things were to happen, soaring inflation would leave the Fed with little choice but to keep aggressively hiking rates, even if it pushes the economy into a recession or makes an existing recession worse.

Owning energy commodities, gold, and Treasury inflation-protected securities (TIPS) could reduce your investment risk if a gloomier outcome materializes. The US dollar should also do well in that environment.

But if you want to avoid betting on any one scenario playing out, you might want to consider the “all-weather” portfolio I shared here. You may not break return records, but you’ll certainly improve your chances of coming up ahead whatever happens next.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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