Deutsche Bank’s Torsten Slok outlined the 10 risks he most regularly hears from clients as the potential source of a significant slowdown.
While he conceded that in aggregate these could be worrying, he saw plenty of reasons why fears were overblown.
Below, we summarize how Slok countered each of the main worries he hears from clients:
Worry #1: Late cycle signals from credit markets
While Slok agreed that some parts of credit markets related to energy are worrisome, most other markets aren’t. “This shows that some sectors in the economy are not doing well but the rest of the economy is doing just fine,” Slok wrote. “In other words, this does not point to an economy-wide recession but to a recession in certain sectors in the economy.” He also noted that the healthier investment-grade credit markets are open for business and four times the size of riskier high-yield segments.
Worry #2: Slowdown in earnings, including industries not related to energy
Slok think the worst is over regarding these concerns. “With the big fall in oil and big dollar appreciation behind us and with manufacturing ISM rebounding there are good reasons to believe that the slowdown in S&P500 earnings is temporary and we should over the coming quarters see a rebound is overall earnings,” he said. In other words, given the turnaround in oil and the dollar, earnings are likely to accelerate.
Worry #3: Profit margins at all time highs
Wage growth is one of the bigger risks pressuring margins. But Slok said he believes wage growth is likely to continue to be slower than revenue growth, meaning that margins are likely to continue to stay high.
Worry #4: China, including Chinese foreign exchange policy, non-performing loans in Chinese banks, too much leverage and too much dollar denominated debt in Chinese corporates
Slok pointed out that China concerns remain importantly outside the U.S., with an unclear connection to the US economy. Plus, he said he has faith the Chinese government will stabilize the situation. “In my view, the Chinese authorities have over the past several decades again and again proven they have the willingness and ability to manage problems in their economy and I continue to think that they will also be able to manage their current challenges,” he wrote.
Worry #5: Worries about banks' ability and willingness to lend
This is largely a misperception of what’s actually going on. Weekly data for US bank lending growth continues to be around 7% to 8%, as Slok pointed out, indicating that there are no signs of any credit crunch in the banking sector. Plus, he said, there’s been more credit coming from other sources, including a rising share from Fintech.
Worry #6: More downside risk to oil prices and much more adjustment coming from the energy sector
The energy sector has been stepping on the brakes on production in its effort to tighten supply and get prices higher. Energy capex falling 50% since 2014, according to Slok. “We are getting to the end of the runway where the negative impact on GDP will be smaller and smaller,” he said.
Worry #7: Inventory correction
Slok’s response: An inventory correction is obviously temporary and generally only lasts one or two quarters.
Worry #8: The economy cannot handle higher interest rates and therefore the Fed will create a recession once they hike rates
The Fed raised rates in January, and Fed Governor Lael Brainard has said that the turbulence in markets in January and February tightened financial conditions so much that it corresponded to 2-3 additional Fed rate hikes. However, says Slok, the market has rebounded with nonfarm payrolls above 200,000 still. “This suggests that the economy is able to handle higher rates and the Fed hiking rates over the coming quarters is not going to generate a recession,” he said.
Worry #9: Too much debt
Slok explained that debt levels on their own don't matter for growth. Instead, what matters are the costs of borrowing, “which generally continue to be very low for both the private sector and government sector in the US. “
Worry #10: Increased vulnerability of the US economy and the global economy as central banks have run out of ammunition
Slok explained that this issue is not an argument why the US should enter a recession soon. It is more a hypothetical topic in case the economy is hit with a negative shock.
The bottom line: Slok doesn’t see any of the key concerns from clients to be worrisome. While the 2008-2009 recession was caused by a banking and housing crisis, this stood unique versus other recent recessions. The 2000-2001 recession was triggered by a big IT capex bubble, the early 1990s came from commercial real estate. “Investors should not think that the next recession will be driven by the same forces that triggered the last recession,” Slok said.