Recession is coming, although it may be a toss-up whether it reaches the UK or the US first. The price relationship between fixed-interest stocks and equities is broken. But, increasingly, it is becoming a stock-pickers’ market. How miserable – or otherwise – should these developments leave investors?
Depends which actually come to pass and how long each persists. Recession is around the corner, or so we keep being told, and it looks like materialising in the US before it arrives in the UK. In the US, inflation-adjusted output fell quarter on quarter in 2022’s first quarter, whereas it just scraped a positive figure in the UK. On that basis, the US could be in recession by the end of the week, when provisional GDP data for the second quarter has been released, whereas the UK is still a minimum of more than three months away. Whichever, financial markets are signalling the virtual certainty of recession since some short-term interest rates are higher than long-term rates.
This is the so-called inverted yield curve, a rare phenomenon which gets economists very excited. Normally – and logically – interest rates on long-term debt are higher than on short-term debt. After all, if, say, I lend to the UK government for 10 years (ie, I buy a gilt-edge stock with 10 years to maturity) then I want a higher return than if I lend for two years. Why else would I risk tying up capital for so much longer without extra compensation? However, occasionally something happens to mess up this relationship and higher rates are on offer on, say, two-year debt than on the 10-year variety.