Why are markets in denial about a recession?
Equity markets are in denial about the potential impact of a US recession and failing to price it in, according to Platinum.
Julian McCormack, investment analyst at Platinum, said the market was failing to price in how bad a recession could be on markets based on historical events.
Factors such as sharp increases in interest rates, rising inflation and US bank collapses were all paving the way for a recession on the horizon.
Rates in the US had risen from 0.25 per cent in April 2022 to 5.25 per cent while in Australia, the Reserve Bank of Australia (RBA) had increased them from 0.1 per cent to 3.85 per cent.
He said the firm had been expecting rising inflation since 2021, which peaked at 9 per cent in the US in June 2022 and 7.75 per cent in Australia at the end of 2022, and did not think markets had priced this in.
Now investors had “persistent bullishness” over future market returns and were disregarding how bad a recession could be.
“We see this persistent bullishness in equity markets — a refusal to believe that the recession that we are entering is really a recession,” McCormack said.
“We’d argue that the obvious thing in 2021 was inflation; the obvious thing now is a recession and we’d posit to you that this is not being priced in by equity markets.”
Analysts in the US were currently pricing in the expectation of an initial 2 per cent decline in earnings followed by a robust 10 per cent increase the following year.
However, this would be a small volume compared to what had happened in previous recessions, McCormack said. In the 2008–09 Global Financial Crisis, the S&P 500 saw a 50 per cent decline in earnings, while the recession of 2001 saw earnings growth decline by 20 per cent.
“If you look back at all the recent recessions in the US, these were all accompanied by very, very significant declines in earnings.”
This meant the firm was focused on achieving capital preservation for its investors.
“We are very, very focused on capital preservation and also have to take into account this ongoing bullishness by equity market participants. We won’t be bloody-minded for the sake of it but will seek to preserve capital through a difficult economic period.”
Earlier this week, Vanguard’s chief investment officer, Gregory Davis, forecast there was a 50 per cent chance of a recession in Australia and a 90 per cent chance of one in America within the next 12 months.
AUTHOR
Laura Dew
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