Are We Right to Be Scared of a Recession?

Current topics with regard to the economy, investment (responsible investment in particular), pensions, and income: Every week, an expert at APG provides a clear answer to the “Question of the week”. This time, macroeconomist and senior strategist Charles Kalshoven explains whether we’re right to be scared of a recession.

Although the economy rapidly recovered immediately after the pandemic, the current outlook for the global economy is worsening once again. The war in Ukraine and a new wave of COVID-19 in China, which has caused another partial lockdown of the country’s economy, are weighing on growth. Disrupted supply chains for energy and machine parts—or fears of disruption—are further pushing up prices. And inflation was sky-high even before all this. Central banks are now fast-tracking measures and, one after the other, raising interest rates. But won’t that put us into recession? Is the fear of a period of economic downturn—with the risk of more bankruptcies, higher unemployment, and falling tax revenues—the reason for the current stock market plunge?

Investors
“Almost every recession is preceded by a bad stock market performance. But this doesn’t work in reverse. Not every bear market, meaning a 20% decline in stock prices, is followed by a recession. It’s often a false alarm,” argues Kalshoven. “If you look at companies’ recent profit figures, they’re reasonably as expected. It’s also not the case that analysts have become more negative about next year’s profits. So, these factors don’t necessarily point towards a recession. Interest rates are the more likely cause of falling stock market prices. When interest rates rise, the present value of future profits falls. This in turn translates into lower stock market prices. A degree of uncertainty plays a role in this value, such as how exactly the tightening of monetary policy will affect the economy. Will we manage to contain inflation without causing excessive collateral damage to growth? The Bank of England, for example, has already warned that the British economy will enter recession later this year.”

Economic Shock
“There are enough other sources of uncertainty, whether about the developments themselves—the war in Ukraine or fresh lockdowns in fall—or their impact. The past years have been so eventful that we can’t really know for sure whether historic relations are still relevant. We’re coming out of the pandemic, which delivered an unparalleled economic shock. The response from central banks and governments, pulling out all the stops to bear the brunt of the impact, was unprecedented. The end of the pandemic led to a sudden recovery in demand. The pandemic had also caused gaps in the labor market, with people quitting their jobs en masse, leading to the current staff shortages. That’s another economic shock we’re having to deal with. And here, in the West, we’ve identified new Omicron variants from South Africa. Although these variants appear to be milder than previous ones, there are still many uncertainties. Predicting the future has always been a tricky business; that applies now more than ever. So, it’s hard to say whether there will be a recession.”

Excesses
Until recently, all economic indicators were positive. Does this mean that the consequences of a possible recession might not be so bad? “It won’t be a textbook recession, which is a result of economic overheating. A period of optimism eventually leads to excessive credit growth, which destabilizes house prices and stock market prices. If wages and prices grow too rapidly, central banks intervene by raising interest rates. But this isn’t a classic case of excesses. The pandemic meant consumers were unable to spend their money and instead accumulated a large stock of savings. There was also a huge degree of government support that kept companies afloat. And while the current mass staff shortages are driving up wages, the cause lies elsewhere. The pandemic shut down entire sectors of the economy, causing staff to get up and leave. A sudden swing in demand, from zero to full throttle, will doubtless create problems. The situation will resolve itself, possibly through higher wages, but that doesn’t mean it’s a classic wage-price spiral. A normal recession is needed to ‘cleanse’ the economy of excesses, but that’s not the case now. With that in mind, I don’t expect a drawn-out, exasperating recession—if there even is one.”