BofA Is Already Talking About A Recession

BofA Is Already Talking About A Recession

The economic crisis generated by covid-19 has been different from all the others in many aspects. The measures adopted to contain the spread of the virus generated a sudden recession , with a quick and deep drop in activity, but of short duration. The recovery has also followed a similar (although not symmetrical) pattern , allowing economies to rebound and back to square one in a few quarters. This singularity could be generating one of the shortest economic cycles in history.

Many economies are already facing their limits to growth, which is going to lead the central bank to accelerate its monetary cycle, withdrawing stimulus and raising rates several times in a few quarters. Although the recovery has started ‘four days’ ago, it may be timely to prepare for the end of the cycle, warn economists at Bank of America Merrill Lynch. Compared to the long recovery from the previous crisis, this time the situation seems totally different: “An unusually strong recovery implies an unusually short cycle.”

“Global growth momentum will start to fade. Low spare capacity and tighter monetary policy are set to see US growth fall to trend this year. In China, growth momentum is expected to remain soft.” given the housing sector headwinds, lockdowns and lack of coordinated easing policies,” Sebastian Raedler, Thomas Pearce, Andreas Bruckner and Milla Savova write in a new post. We expect the same for the euro area , which has more capacity. ” idle (higher unemployment and lower wage pressures) but also faces cyclical headwinds from a negative fiscal impulse, slowing money supply growth and high energy prices.

In the US, the situation is clear: inflation is well above the Fed’s target , companies cannot find a workforce, wages are growing strongly, and the economy has already reached pre-pandemic levels. To all of the above we must add the stimuli that are still ‘going around’ in the US economy and that can continue to exacerbate everything described above. Now all that remains is to wait for the Federal Reserve rate hikes and try to take advantage of the opportunities that appear in this environment of monetary contraction.

“The end of the cycle is in sight. The US economy has ‘used up’ its spare capacity (workers and capital that had been unemployed or unused during the recession) very quickly, helped by generous fiscal support and currency,” say economists at Bank of America Merrill Lynch.

So BofAML experts”expect the US output gap to turn positive in the coming quarters, which is generally associated with higher risks of below-trend growth going forward, in part caused by the lack of available capacity and partly by the restrictive policy that it generates”.

The growth of the economy in nominal terms will begin to have an increasingly greater component linked to the increase in prices and a smaller dose of real growth (meager growth that improves the well-being of societies). As the economy continues to exceed its potential, producing more goods and services will become more complex, while if demand remains strong, this will only lead to a price boom. The Fed will have to cool demand with a more restrictive policy to prevent inflation from becoming chronic.

“This suggests that US GDP growth will fall below trend in mid-2023, which also means that the safety cushion between the economy and the next recession will shrink more and more ,” say experts from the American bank. .

How to invest in this scenario?
Although as the cycle progresses it may become more complex to obtain considerable real returns. From BofAML they give several keys that could shape the market in this type of scenario. First, European equities in general will be negative: “A rise in real bond yields implies a drop of around 10% for the Stoxx 600 by the end of the year.”

On the other hand, these experts recommend ‘overweighting’ utilities : projections of lower growth in the euro area are consistent with an additional 6% outperformance of this sector, which tends to be more defensive. It also recommends ‘overweighting’ the sector of banks that will take advantage of higher interest rates that will allow the sector to outperform the European indices.

Who are the victims?
“Underweight Autos – This high beta cyclical sector typically moves in line with global growth momentum, which we expect to continue to fade, implying a 10% underperformance against key equity indices. Underweight Mining – Our Projections of dollar strength (aided by rising global macroeconomic uncertainty) and moderate China PMIs point to a 15% or more underperformance against the major indices.

A good part of these movements can already be perceived in the markets. Banking has undoubtedly been the great protagonist of the stock market in recent months. Once central banks have been forced to change their tune and anticipate the arrival of monetary tightening, bank prices have soared. Some of the most impressive cases can even be seen in the Spanish stock markets, where several entities have multiplied their share price by more than two since this monetary turn began to take shape.

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