Should We be Worried About an Impending Recession? | Barita Insights | July 4, 2022

Analyst Insight

Introduction

The bank of Jamaica in May would have stated that they see no “major risk” of a recession, with growth expected to continue into next year (2023). These fears would have been born out of economic data from the US increasingly pointing to the potential for an economic slowdown there. This has therefore led to many pertinent questions from the investing public. Namely, should we be worried about a recession? And if so how does one position themselves for such a prospect? Hence in this piece, we will go over the current conditions globally, then the domestic macro environment, the interlinkages between the two, and then finally, just how worried should we be and the investment implications.

What’s a recession?
The textbook definition of a recession is two consecutive quarters of real GDP decline. A more comprehensive definition by NBER (The National Bureau of Economic research based in America) considers wider factors such as employment, and real income, as well as the depth and breadth of the decline. Based on the technical definition, the US economy is one negative quarter away from being in a recession following the 1.6% annualised decline for Q1 2022. This possibility is further cemented by the Atlanta Fed’s(Branch of the Federal Reserve, America’s equivalent of the Bank of Jamaica) “nowcast” of Q2 2022 GDP growth of -2.1% as of the 27th of June. Hence for a technical recession to be avoided the preliminary 2nd-quarter GDP reading would need to surprise on the upside by 2.1%, which has never happened throughout the 11 years of GDP now estimates that we have looked at (assuming no changes between now and the final nowcast on July 27th).

The situation in The US
The factors driving these conditions are well broadcasted. These include, inflationary pressures from supply chain bottlenecks and the uncertainty caused by geopolitical issues. This has necessitated a shift toward contractionary monetary policy globally. Hence global consumption and production capacity has been hit by uncertainty, supply issues, inflation and rising interest rates which have aided in reducing consumer and business confidence. This is evidenced by the first quarter US GDP outturn as well as the aforementioned Q2 nowcast featuring a negative drag from a drawdown in private inventories (as well as the Q2 2022 featuring a slow down of consumer spending).Essentially, these out turns reflect slowing consumer spending being matched by heightened levels of inventory as private businesses remained overstocked as seen by the ratio of private inventory to sales of domestic businesses in the US as of Q1 2022 being at its highest level since 2014. Hence, given the overstocking, declining consumer confidence and more persistent than expected inflation, we see plenty of headwinds for growth for the remainder of 2022 with the US likely already being in a technical recession.

Domestic Environment
In the local context the distinction between a technical recession and a more comprehensive measure becomes important once again. This is because if measured through a similar methodology reported for the US (real annualized quarter over quarter seasonally adjusted GDP), Jamaica would also be on the verge of a “technical recession”(following an annualized decline of 4.64% for Q1 2022). However, other indicators of the health of the economy such as the unemployment rate (new low of 6.2% inJanuary) and the lack of a widespread decline in multiple industries would suggest a healthier economy when looked at through a broader lens. This sentiment is also echoed by forecasters who still project on a year-over-year basis the Jamaican economy will continue its above-average growth, with Real GDP growth projected to be 3.3% for 2023 by the IMF (who of note typically also uses a broader definition of recession to include employment, income, industrial production, etc.) who also are also of the opinion that a recession will be avoided.

The interconnectedness of the world does however mean that we cannot ignore the possible impact of a US recession on the domestic economy. The US remains a major source of external demand for Jamaican goods including our tourism product (on a side note the US conference board consumer confidence survey has shown that the proportion of Americans planning to vacation in the next 6 months continues to decline) and a source of secondary income through remittances which bolster domestic consumption. Despite the possibilities of contagion from a weakening US economy, domestically this hasn’t been shown fully in recent data. That is, remittances remain strong, despite being marginally lower for the first 4 months of 2022 than the corresponding period in 2021. Additionally, tourist stop over arrivals continued its strong recovery with the March 2022 figures being simultaneously 193% higher than March 2021 and still only 80% of the pre- pandemic March 2019 figures.

We note that there remains room for further recovery, particularly in sectors such as mining and quarrying (which the BOJ noted should pick up later this fiscal year) as well as the transport and restaurant services sectors which remain well below their pre-pandemic levels by 72% and 34% respectively. Despite this, we believe a slowdown to trend growth, which is inevitable, is likely to happen at a faster pace given headwinds from possible further weakening in external demand which may show with a lag, the return to more conservative fiscal policy and the current tight monetary policy stance by the BOJ (which has already impacted new credit availability and has influenced a marginal increase in domestic lending rates) with other headwinds including the continued strength shown by global commodity prices. While we still expect to see in the short term potential “recovery sectors” continuing to bolster growth, the risk of a recession beyond that, given the lagged impact of policy measures and the assumption of a continuation of global financial pressures makes the recession risks impossible to ignore in the medium-term.

Implications
In this context, we believe the investment outlook domestically is fairly clear. That is, the incentive to maintain adequate liquidity is high. This being twofold, a recessionary backdrop typically does not bode well for risk assets, particularly when mixed with contractionary monetary policy. The bank of Jamaica through its policy actions is therefore also rewarding the investor for prioritizing liquidity with money market rates tracking policy rates more closely than other market rates. Therefore, an investor could benefit from higher rates and enhance liquidity by investing in money market funds (with Barita’s Unit trust allowing investors to do so). While this is not to say investors should shy away from equities, we now encourage more astute security selection than ever before. This is a necessity, as disposable income gets squeezed by higher prices, leading to changing consumption patterns and a weaker ability of businesses to pass on price increases. As such, this reflects the importance of opting for companies in sectors with relatively inelastic demand for their goods (pharmaceutical or companies in the medical sector such as Elite Diagnostics for e.g.) as well as ones with a wide footprint in defensive sectors such as consumer discretionary (think Grace Kennedy for example).