“Everyone asks me when the US expansion is going to come to an end”, says Hodgson. Indeed, just before speaking to us, he had just come from a meeting on the topic. While he doesn’t think that an immediate recession is on the cards, he thinks that investors are right to be worried, especially because this current US expansion has been much longer than most cycles (which tend to be typically around 15 quarters). The 38 consecutive quarters of economic growth since 2009 make it “the second longest expansion since World War Two”, second only to the period between 1991 and 2001, which lasted 40 quarters.
“I’m not a trained economist”, he admits, so he isn’t able to make a definite forecast. However, Hodgson has learned which economists to pay attention to, and he notes that Goldman Sachs, who have the best reputation for predicting recessions, are now putting the chances of a downturn at around 20%, based on survey data. As a point of comparison, just before the downturns in 2000/1 and 2007/8 they were putting the chances of a recession at around 30-40%. So, its reasonably safe to conclude that, if a recession is not immediately around the corner, it is certainly not that far off, even if recent GDP data has been more encouraging.
However, even if the US and UK economies manage to avoid falling into a recession, central bank tinkering could end up slowing the economy down to a near standstill. In particular, Hodgson is also concerned about the direction of interest rates. While Bank of England governor Mark Carney is still an “unreliable boyfriend”, constantly changing his view on the outlook for the British economy, it is hard to dispute that rates are now “slowly and steadily rising”. This is bad new for consumers, who will see their mortgage payments increase, but it isn’t that great for companies either, who will see the cost of servicing their debt rise.
With markets “choppy” at the moment, Hodgson thinks that, “sensible asset allocation in this environment involves not taking on too much risk”. However, it would be a bad idea to ditch shares altogether. He notes that many hedge funds got burned, even to the extent of being forced to shut up shop, over the past few years when their bearishness panicked them into becoming too bearish. A few even made the mistake of going short and were eventually forced to cover their positions at a large loss when the market continued going up.
So, which sectors should you avoid? In a recessionary environment, you would normally avoid growth stocks and smaller companies, though there is a chance that they could end up going higher before the market turns. He also had mixed views on emerging markets. While some markets may seem attractive, they will suffer if the dollar goes higher and there is a further flight to quality. More generally, “it is time to batten down the hatches” and adopt a more defensive posture. The pessimistic investor might also want to consider buying some gold, though more as a diversifier, “since it doesn’t pay a dividend”.
It is important to note that some shares should still do well. Hodgson thinks that “investors have become overly nervous after the populist triumph in Italy’s March elections” with the result “there have been big outflows from Italian and European markets”. However, they overlook “that the fundamentals are good. This means that more adventurous investors should consider buying some European shares, to take advantage of the fact that they are expected to outperform over the next six to 12 months”. Hodgson also likes shares in global companies with good brands that will provide some security.