Global Market Observations: Is a Recession a Foregone Conclusion?

Global Market Observations: Is a Recession a Foregone Conclusion?

Adam Sparkman
I’m Adam Sparkman, a client portfolio manager with Thornburg Investment Management. Today, we’re continuing our observations in fixed income and Global Equities series I’m joined by Ben Kirby and Jeff Klinghoffer, co-heads of investment firm Thornburg Investment Management. Jeff, I think your outlook as far as a recession goes is kind of potential mild recession in the US by late 2023 early 2024. When you look out at the market, what are some of the indicators that are helping inform that opinion and within the global fixed income team how are you positioning the portfolios for that that sort of outcome?

Jeff Klingelhofer
Sure. And I think as part of that question, I want to rewind the clock even 2022 going into 2023. We and the market broadly expected a relatively significant recession in the first half of 2023 and here we are, we don’t have one yet. And why. It’s because primarily the strength, the exceptional strength of the US consumer. The key I think to forecasting when and where the economy ultimately does tip over is to keep a very close eye on the US consumer.

What we’re seeing is a number of leading indicators suggest that at the levels that they are today, right whether it be yield curve as inverted as it is or leading economic indicators as negative as it is a credit condition in conditions having tightened as much as they have, all of them point to what traditionally it would be. We are imminently heading or already in a deep recession.

But again, we’re not. The consumer on the back of covered stimulus has been incredibly, incredibly strong and really to the detriment of the Fed’s ability to fight inflation. Right. Labor markets have been very, very resilient. What we are seeing is a rapid deterioration of that strong starting point within the consumer. Right? So, we’re seeing credit card delinquencies tick up.

We’re seeing auto delinquencies tick up. We’re starting to see the very early inklings of that happening within the housing market as well. Now, when you zoom out a little bit, you realize that, yes, they’re rising at a rapid clip, but they still aren’t even back to a more normalized level. And so, the question is, do they go to that normalized level or even beyond?

We think they do, right? We think ultimately the Fed tightening credit conditions, the cost of higher rates is slowing. The consumer but it’s going to take a while to play out. And so that’s why we continue to expect a mild recession in the later part of 2023 or perhaps the early part of 2024. But really, for us, all eyes will be on the U.S. consumer, on the strength of that consumer.

Adam Sparkman
So, Ben, kind of to Jeff’s point about the cost of higher rates, one theme that I’ve heard you emphasized quite a bit lately is this structural shift from a environment of near zero interest rate money to one where capital really has a cost. Again, what types of companies or maybe potentially geography sectors do you think are poised to benefit from this regime change?

Ben Kirby
Yeah, so we’re calling it the cost of capital normalization. So, we went through a 15 year period of rates being zero for most of the time. And then, you know, above zero for a short part of that time. Overall, it was an abnormal period. And normally capital has a cost to it. It’s not free. So, as you go into an environment where we do have a higher cost of capital, we think that favors companies that have more durable businesses and stronger competitive moats.

So, in the zero cost of capital environment, a lot of companies that were losing money. So, I mean even maybe losing money at gross margin. So, you lose money on every customer, but go get more customers. That kind of a business model that’s getting washed out to sea right now. There’s just not an appetite for it. There’s not a lot of funding for those kind of companies anymore.

So, you know, we think that the beneficiaries, as we go forward will be those stronger incumbent companies. Maybe they have slower growth, but they have stronger, more resilient businesses. They can survive a higher cost of capital and actually take market share back in this environment.

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