Darius McDermott: Is waiting for recession a foolish game?

It was not long after lunch on the final day that pessimism ruled the roost with England nine wickets down and the Ashes seemingly staying with the Aussies. Enter Ben Stokes with the most remarkable batting display I have seen since, well, the World Cup final six weeks earlier. Within an hour the mood of English cricket fans had gone from down in the dumps to one of euphoria. 

Sentiment within investment markets has been changing with a worrying amount of regularity through 2019, as late cycle concerns, coupled with the daily changes to the Brexit and Trade War scenarios, continue to spook investors. 

One of the latest bouts of anxiety was caused by the news that both the US and UK yield curve started to invert. It has historically been touted as a red flag that recession is on the way - particularly in the US.

The yield curve is the difference between the interest rate on a longer-dated bond and a shorter-dated bond. Naturally it should cost less to borrow money for two years as opposed to 10 - the opposite is now true. The news immediately resulted in a sell-off in markets.

I would never dismiss the inversion, but I do feel there has been something of an overreaction, from many different parts of the industry, to the move in stock markets. We know the yield curve typically leads to a recession after 18 months in the US, and while it does not guarantee a recession in the UK, if the US does go into recession it is hard not to see it bringing other nations with it.

But there are reasons to not be overly pessimistic. First of all, the inversion is a good guide for recession, but it is by no means a certainty. For example, the quantitative easing measures made by global central banks may have driven down longer-term yields and diluted the impact of the yield curve's reliability to indicate a recession.

There is also a train of thought that negative yields in Europe and Japan may have forced investors searching for yield to turn their attention to the US and therefore depress long-term yields.

A recent note I read from Liontrust fund manager James Inglis-Jones also pointed out other factors make the move more complicated than many headlines suggest. For example, he says: "Yield curves can also be shaped by structural factors such as large groups of investors (such as pension funds) needing to buy bonds of a certain maturity." 

I think this is another indicator of the late cycle scenario we have been in for the past three years. Yes, we are cautious on markets, but there are many other major catalysts to consider in the next 18 months (before doom supposedly strikes).

For example, as we move towards the latest Brexit deadline, we have no clue as to whether a deal will bring an opportunity for markets or whether a no deal scenario will hit sentiment even further - and probably take us into recession. The same can be said for the trade war between the US and China - where a potential deal could give markets a strong injection of confidence.

As I mentioned, we are cautious. The simple fact is markets have been grinding upwards for more than a decade - but there is still money being held on the sidelines due to the uncertainty caused by geopolitical events. We are now a decade past from one of the most unique events in history: that uniqueness is still impacting markets to this day.

For those who are cautious I would recommend they look towards a couple of mixed asset vehicles, such as Premier Multi-Asset Monthly Income or VT Seneca Diversified Income. If you are a tad more confident, I would consider a global equities fund with an element of capital preservation, such as Fidelity Global Dividend.

Darius McDermott is managing director of Chelsea Financial Services and FundCalibre

• Tweet  
• Facebook  
• LinkedIn  
• Send to  

• Topics
• Markets
• bonds
• USA