Mid-cycle correction not imminent recession
We remain of the view this is not yet at the end of this cycle. We are reminded of a similar mid-cycle correction in 2011. During that episode the S&P 500 dropped by around 20%, peak-to-trough, so these can be very painful experiences. As a result, we are being very cautious in our short-term outlook.
But on a 12-month basis we maintain our modest risk-on bias. In fact we have become even more confident in our medium-term return outlooks, given the sell-offs that we have seen.
We think this slowdown will eventually offer some attractive entry points to add risk to portfolios, particularly in parts of the credit markets. The key word, of course, is ‘eventually’. Given the recent poor data, we will certainly need to see some manifestation of the increase in credit defaults that has been forecast, and some re-ratings of BBBs to BBs, before we feel things have truly bottomed out.
The same applies to what is happening with oil: We want evidence of real production cuts from a marginal non-OPEC player (or even an OPEC producer), as well as signs the rig-count and capex declines in the US are leading to reduced production. Once these things are built into the environment – possibly by the coming summer – we think it will be an opportune time to consider adding risk.
Until then, we are watching carefully for any further signs of deterioration. We still worry most about China, and any significant further decline of the yuan would be the signal to revisit our thesis. A 10%-plus devaluation would suggest China may be going through a ‘hard landing’, potentially triggering currency wars and global deflation.
This is far from our base case, however. Our watchword is caution – but caution in scouting for opportunities over the coming months.
