If there’s one word that can turn a bull market into a bear market overnight, it’s the dreaded R-word. This week, DataTrek Research co-founder Nicholas Colas raised some eyebrows with a note discussing his outlook for the second half of 2018.
“Let me offer up a one-word summary of how I see the second half of 2018 for equities: ‘Recession,’” Colas said.
The following three phenomena are the primary concerns for corporate managers in determining how much money they spend and how many employees they hire — or fire — between now and the end of the year, Colas said.
1. Tariff Uncertainty
Capex and hiring are planned well in advance, meaning recent first-half uncertainty related to international trade wars might not start to rear its ugly head until the second half of the year, Colas said. If the trade war drags on, managers will start to get spooked about the potential impact on business, which will lead them to dial back spending and even potentially reducing headcount, he said. That type of fear tends to cascade as other managers are rattled by falling employment numbers and earnings.
2. As Good As It Gets?
The second phenomenon that Colas said could trigger recession fears is the fact that the U.S. economy is firing on all cylinders, and spending and earnings growth potentially have nowhere to go but down.
For example, Colas said earnings growth has been red-hot in recent quarters, yet it's expected to drop from 25 percent in Q1 to just 20 percent in Q2. GDP growth in Q3 and Q4 will also likely fail to reach the at-or-near 3-percent level economists expect in Q2. If managers see decelerating growth numbers as signs of a peak in the economic cycle, it could create the dreaded negative feedback loop that triggers a recession, Colas said.
3. Flattening Yield Curve
Federal Reserve policy is another wildcard for the economy, Colas said. The yield curve has been steadily flattening. The spread between two-year and 10-year Treasuries dropped to just 0.31 percent this week, the lowest level since July 2007. Historically, when that spread hits zero, a recession is imminent.
Fortunately for investors, Colas said recession fears will come into play in the next two quarters, but that doesn’t necessarily mean a recession will play out.
“We don’t see a recession in 2018 or 2019, but we believe the dominant market narrative will revolve around this topic in the back half of 2018,” he said
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