It is “inconceivable” that the US will enter a recession within the next 18 months, according to Merian Global Investors' chief executive Richard Buxton (pictured), who says an inverted yield curve cannot be used to predict a downturn with long-dated bonds so mispriced
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Numerous fund managers have recently warned the period of economic expansion in the US is now entering its final stages: Jupiter Strategic Bond’s Ariel Bezalel recently said, “we believe we are a year to a year-and-a-half away from recession”, while Royal London’s Trevor Greetham told investors they had six to nine months “to get their house in order”.
Yet Buxton – manager of the £1.9bn Merian UK Alpha fund – said this is quite encouraging for contrarian investors such as himself, because if everyone is positioning for a downturn, it is probably not going to happen.
“We have had this story all year of rising US interest rates, this tightening of liquidity as the Federal Reserve has begun to withdraw this extraordinary QE,” he said.
“All that has changed is investors’ sentiment and their positioning. In January people were pretty euphoric, a ‘melt-up’ was the phrase, one of the last phases in equity markets before a bubble.
“And, actually, people are now very defensively positioned. If you look at fund manager surveys, there is a lot of cash there, people are positioned in a lot of defensive sectors.
“It has become almost a given among many economists and commentators that no matter how strong the US economy is at the moment, if the Fed keeps on raising interest rates then actually there will be a recession in the US in 2020. It has even been on the front page of The Economist, so you know it is not going to happen.”
One of the main reasons why analysts are predicting a recession is the narrowing of the yield curve – the difference in yields between short-dated and long-dated bonds – which tends to invert 18 to 34 months before a recession.
However, Buxton’s argument is that yields on long-dated bonds are too low and, while these tend to fall before an economic downturn, all the signs suggest they are likely to rise further from here.
“As the Fed begins to reduce all this extraordinary stimulus and you haven’t got all this central bank buying of bonds, and because of the Trump tax cuts, it is issuing more bonds than it has issued before,” he said.
“And a small footnote is that the Chinese aren’t buying them anymore, because the Chinese current account surplus has disappeared and now it is a net borrower from global markets.
“So it is actually rising yields that you will start to see, and indeed it has been rising yields in recent weeks that have caused a lot of the setback in risk assets. Despite which, the economists are still adamant we will have a recession in the US in 2020.”
Another reason why Buxton is upbeat is that real interest rates – meaning interest rates after inflation is taken into account – have only just turned positive.
“The US economy is on fire at the moment,” he added. “When I talk to businesses in America, they are seeing double-digit revenue growth. This is completely unsustainable, but with real interest rates still only just having moved slightly positive, it is inconceivable to me that suddenly the US is going to come to a juddering halt and be in a recession within 18 months.
“Of course, it is going to slow. You are already starting to see data from real interest rate-sensitive areas such as housing and auto sales beginning to slow.
“But for me, by the time the Fed raises rates in March, that data will be pretty compelling and it will start softening its rhetoric about continuing to raise interest rates every single quarter next year.
“So, I think the phrase we will be hearing next year is ‘a soft landing for the US economy’.”
Buxton is not the only manager who thinks a recession is unlikely. Stefan Isaacs, manager of M&G European Corporate Bond and co-manager of M&G Optimal Income, said that while the period of economic expansion has been one of the longest on record, the amount of growth it has generated is well below the amount seen in all other expansions since 1949.
Isaacs said this was to be expected given the length and breadth of the previous downturn.
“It wasn’t your typical recession, it took time for the authorities to respond to the sheer magnitude,” he explained.
“So arguably animal spirits are still damaged from what we saw 10 years ago and so the amount of growth we have generated has been poor. And that has implications for the response from central banks. Central banks never manage a gradual slowdown, it always ends in recession.
“But in this instance, and I’m always nervous of saying ‘this time is different’, I do believe that central banks do have more time in the way they approach the normalisation of monetary policy.”
Buxton said the uptick in volatility this year is healthy and was entirely predictable, adding that the stability seen in 2017 “when Wall Street only fell by more than 1 per cent on 11 trading days” was unprecedented.
He also said that it is important to separate the weakness in the global market from the strength of the underlying economy, pointing to data from the International Monetary Fund showing that more economies are now growing than at any point since the financial crisis.
However, he admitted that unwinding the unprecedented level of money printing of the past decade was never going to be easy.
“It’s completely uncharted territory. We are living through a financial experiment and there is bound to be the odd sort of hiccup,” he continued.
“And, of course, markets themselves have their own cause for concern – if risk assets do fall materially, if they fall 30 per cent, would that in fact impact industrial confidence, business confidence, consumer confidence and become a self-fulfilling prediction of a downturn?
“The underlying strength of the economic activity which will support profits growth is not necessarily a given, so we’ve got to keep a close eye on it,” Buxton finished.
Data from FE Analytics shows that Merian UK Alpha has made 110.79 per cent since Buxton joined in December 2009, compared with 100.96 per cent from its IA UK All Companies sector and 95.5 per cent from its FTSE All Share benchmark.
Performance of fund vs sector and index over manager tenure
Source: FE Analytics
The fund has ongoing charges of 0.85 per cent.