A US recession is now “virtually inevitable”, argues the ever bearish Albert Edwards at Societe Generale. The Federal Reserve’s decision to “back-pedal furiously” on rate hikes has resulted in a recovery for risk assets, particularly emerging markets. Yet, “while the Fed plays its games, the economic cycle is withering and writhing from within”.
Edwards notes that the US national accounts show that company profits are falling, squeezed both by rising wages and falling pricing power. This in turn tends to be a leading indicator for business investment – and “historically, all recessions are effectively caused by slumps in business investment driven by a profits downturn”.
Now, that doesn’t mean a recession is automatically baked in – a slump in business investment doesn’t “necessarily generate an outright recession as was the case in 1985/1986”. However, the backdrop is less forgiving today than back then.
For example, in 1986 the Fed cut interest rates from “over 8% to less than 6% at a time when the consumer was re-leveraging”, rather than paying off debt as is the case now. Nor were companies “up to their necks in debt as they currently are, and their solvency now is far more vulnerable to a profits downturn”. Indeed, says Edwards, “if I had to pick one asset class to avoid, it would be US corporate bonds, for which sky-high default rates will shock investors”.