Put another way, while there are some similarities between the 2018 landscape and what happened in the 1970s, there are conditions in place now — demographics, technology, monetary policy — that argue against a return to a condition so drastic that former Fed Chairman Paul Volcker had to take the country into recession to cure it.
Fundamentals also are much better now than they were then. Business and consumer confidence is soaring, corporate profits are near record highs and interest rates, while rising, are still low.
But the sudden deterioration of any of those conditions, much like the slowdown happening in other parts of the world, is what worries Paulsen.
“You could get yourself into a situation where you’re growing more slowly,” he said. “A milder version, but nonetheless a version, of [a late-1970s economy] is a possibility.”
Paulsen worries that an overheating in the economy eventually could lead to trouble, paving the way for another tightening in financial conditions that brings the expansion to a halt. Inflation measures have been creeping higher, resulting in a push to a seven-year high in the 10-year yield.
One area of worry is the Federal Reserve.
The central bank is on a rate-hiking cycle that began in December 2015 and likely will continue through next year and perhaps into 2020. Market participants worry that the Fed will keep hiking until it inverts the yield curve, a condition where short-dated yields exceed their longer-duration counterparts. That has been a reliable recession indicator for 50 years, and it’s close to happening again.
The idea that “this time is different,” pushed by Fed officials and elsewhere, could lead investors to be complacent, said Mark Holman, CEO of TwentyFour Asset Management.
“In the absence of a major surprise, some kind of big macro problem somewhere, I think it’s going to be a mild recession and won’t last very long,” he said. “I would caveat that by saying it depends on what tips us in.”
For clues as to when and how the next recession will take hold, Holman recommends watching the Fed’s survey of loan officers, which describes current lending conditions and serves as a benchmark for how loose or tight fiscal conditions are at a given point in time.
“The day the curve does invert, your senior officers at all the big banks in the U.S. are going to be discussing their credit lending strategy,” he said. “Tightening isn’t just what the central bank does.
Ultimately, he sees recession hitting around 2020. Investors should start thinking about that day coming, though he said it’s probably premature to begin adjusting portfolios.
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