No Recession Yet, But Risks Are Rising. Are You Prepared?
By: Jamie Newton, CFA, Allspring Global Investments
In this paper, Jamie Newton, Head of Global Fixed Income Research at Allspring Global Investments, discusses why we have not yet seen a recession, why one is likely coming, and how investors can best prepare for it in the months ahead.
This is an excerpt from NCPERS Fall 2023 issue of PERSist, originally published October 24, 2023.
Where has the continued economic strength come from?
The recession that many have been talking about has yet to arrive. Will we ultimately face one? I can point to three reasons why the long-awaited slowdown has yet to set in:
Companies and individuals have amassed low coupon debt since the Global Financial Crisis. Borrowers used the COVID era to extend maturities at even lower rates, muting some of the effects of rapid rate increases.
Fiscal stimulus from COVID-related packages persists in the economy. Excess savings of companies and consumers have lasted longer than expected, and student loan payment deferrals have increased consumers' spending capacity.
The work-from-home movement continues to be influential. While businesses supported by traditional work arrangements have lost out from this shift, workers are saving money on transportation and meals, further extending their spending capacity.
Is a recession on the horizon?
While these factors have extended the business cycle, I expect we may enter a recession in late 2023 or early 2024 for several reasons:
2. Interest rates are starting to bite. Companies dependent on short-term debt and/or variable-rate debt are feeling the pain. We see this particularly with lower-quality debt, as companies are struggling to absorb increasing interest costs.
3. Higher rates hurt as companies roll their debt. About U.S. $900 billion in corporate bonds and leveraged loans must be paid down or refinanced in 2024 at higher rates. Nearly 30% of the corporate market matures within the next three years.
4. Rate hikes may not be over. While the Consumer Price Index (CPI) is well off its peak, the jobs market remains strong and personal consumption expenditure (PCE) inflation remains elevated.
5. Banks are tightening lending standards and reducing exposures. Access to debt and capital is deteriorating for some borrowers in the wake of the banking turmoil earlier in 2023.
6. Commercial real estate (CRE) faces tighter access to bank lending, reduced rents, and lower occupancies. However, not all CRE sectors are the same—specific locations, lease terms, and financing structures will influence which assets become stressed.
7. Manufacturing, by many accounts, is already in recession. Manufacturing Purchasing Managers' Index (PMI) readings have weakened in the U.S. and around the globe.
What can investors do about it?
Against this backdrop, I believe that investors can protect themselves by taking the following actions:
Don't get caught in the cash trap. Currently attractive short-term rates could be cut quickly near a recession, and longer-term rates could fall as well. Investors can extend their duration over the next several months, lock in higher yields for longer, and position to benefit from lower yields.
Stay diversified. The effects of any recession would likely be felt unevenly across fixed income markets and present an attractive opportunity for sector and issue selection. Broadly speaking, your equity and fixed income exposures should be proactively deployed.
Bias toward quality. Current valuations suggest there will be little reward for reaching down in quality. Focusing on fundamentals—especially leverage, interest coverage, and margins—should be as important as ever as markets and valuation evolve.
About the author: Jamie Newton, CFA is the head of the Global Fixed Income Research team and the deputy head of the Sustainability team at Allspring Global Investments. He joined Allspring from its predecessor firm, Wells Fargo Asset Management (WFAM), where he served as head of the Global Credit Research team and previously as a senior analyst. Jamie began his investment industry career in 1992. He earned a bachelor's degree in economics with an emphasis in accounting from Albion College and a master's degree in business administration with an emphasis in finance from the University of Michigan.
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