The surging oil price, rising interest rates and an inverted slope of the yield curve all suggest the US economy is heading for a recession, according to Yoram Lustig, head of multi-asset solutions at T Rowe Price.
While these three classic harbingers are all pointing to a recession in the world’s largest economy, Lustig says history suggests it may not arrive for a while yet.
“Based on our key indicators – the oil price, Fed policy, and the slope of the yield curve – a recession in the US seems increasingly likely,” he said. “However, history shows that these signs have typically preceded a recession by about an average of two years.”
According to Lustig, a spike in the oil price has preceded five of the six US recessions since 1976, while over the same time period, he notes the Federal Reserves has only succeeded twice in hiking rates without pushing the economy into recession.
Again going back to 1976, Lustig points out that inversions in the yield curve, US treasury 10-year less two-year yield, have preceded each of the six recessions.
“The slope of the yield curve not reflects market expectations, it may also hep cause a recession,” he said.
“The yield curve inverted in March, albeit with the long end of the curve already pushed down by unconventional monetary policy.”
So, how should investors be preparing for a potential upcoming recession?
Lustig says that in addition to maintaining diversification, portfolios should be positioned for a more volatile economic environment to come.
“As the business cycle moves into a downward phase, gains from economically sensitive assets would become more mixed, and investors may look to ensure any gains are banked and stay close to their policy portfolio.
“Markets tend to price in the risk of a recession before it occurs and may become more turbulent,” he added.
“Diversification, both globally and across asset classes, may help mitigate this volatility.”
Additionally, Lustig notes that investors should plan to reposition portfolios for a future recession which he says may be different to prior ones, while also considering “creative” ways to mitigate downside risk.
“If inflation persists and government bond yields continue to trend upward, government bonds may not fulfil their traditional role of diversifying equity risk,” he continued.
“Other approaches, such as active conservative strategies or a wider range of ‘safe‐haven’ assets, may play a defensive role in portfolios.”
This article first appeared on our sister title International Adviser.