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July 06, 2018 at 01:57 PM
What will the U.S. economy look like a year from now, and how should investors prepare in the meantime?
According to David Kelly, chief global strategist at JPMorgan Asset Management, the federal deficit will have climbed to close to 5%, up from just under 4% this year; the 30-year fixed mortgage rate will have reached 5% — it’s currently around 4.5% — and the U.S. economy will be slipping into a recession or nearing one, in 2020.
“Be prepared” for a recession in 2019 or 2020, said Kelly who recently held a webinar on his third quarter outlook.
Despite this prediction, Kelly adamantly advises against timing portfolios based on expectations for when the next recession will occur. “It’s hard to balance when riding a bicycle slowly,” said Kelly, likening riding a slow-moving bike to investing in a slowing economy verging on recession.
(Related: Don’t Expect Active Funds to Outperform in a Bear Market)
Moreover, Kelly is not anticipating a big bear market when the economy does finally retreat into negative territory for several reasons:
- Current stock market valuations are not excessive, with the 12-month forward P/E for the S&P 500 near 16x. The average forward P/E has been 50% higher since 2000, so the market is less vulnerable now.
- The average correction in nine of 11 recessions post-World War II has been 25%, which is nothing to scoff at but it’s half the decline of the last two bear markets.
- The last two recessions, in 2000-2001 and 2007-2009, and the bear markets that followed involved a financial crisis, which is less likely for the next one. Why? The economy is more stable and banks are in much better shape. Unemployment, for example, is more likely to rise to near 7% rather than 10%, as in the last recession.
Before the next U.S. recession occurs, Kelly expects the gap between short-term and long-term bond yields — currently 28 basis points between the two-year and 10-year compared to 132 basis points a year ago — will continue to narrow as the Federal Reserve raises short-term rates and long-term rates rise half as much.
The yield curve will possibly invert, historically a telltale signal of an impending recession, but the inversion, said Kelly, is merely “a symptom, not a disease” and it has some benefits. When long rates fall, it’s easier for consumers to buy a home, and when short-term rate rise, they collect more interest on savings accounts, according to Kelly.
