70% chance of recession in the coming year, says Franklin Templeton

There’s a 70% chance of global recession in the next 12 months as central banks unleash more pain in the form of higher interest rates to combat inflation, now skirting close to double digits in much of the developed world.

“The [US Federal Reserve] is going to have to pull its levers very hard to rein in inflation,” said Peter Vincent, head of client investment solutions for Europe, Middle East and Africa at Franklin Templeton Investments. He was speaking at the Morningstar Investment Conference in Cape Town, last week Wednesday.

This is in line with a Bloomberg Economics projection earlier this month that rated the prospects of a recession a near certainty over the next 12 months.

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Central banks are aggressively hiking interest rates to rein in inflation, and at least two more 50 basis point rate increases are priced into the financial markets before there will be any softening, said Vincent.

Even Japan, where inflation has long been tamed, is starting to see headline inflation at historically high levels.

Influencing factors

Among the factors weighing on the high likelihood of recession are slowing growth prospects in China. The Chinese government’s zero tolerance to Covid, accompanied by rolling lockdowns across entire cities, has created considerable headwinds for the economy.

China doesn’t have the flexibility to respond to a slowing economy, raising the spectre of overstimulation and widespread default.

“Inflation has evolved into the service sector, but there are signs of it peaking,” added Vincent.

“Higher interest rates are showing signs of working. The bargaining power of labour will be key to taming inflation.”

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Europe is attempting to wean itself off Russian energy imports as a response to the Ukraine invasion, but it will be hard to replace them completely. Europe’s natural gas stockpiles are in line with those of previous years, prior to Covid, though the sabotage of the Nord Stream pipeline on the eve of the European winter will place consumers under even more pressure from rising prices and diminishing stockpiles.

Opportunities

In this challenging environment, failing companies will be allowed to fail, but there will be opportunities for discriminating investors to profit, said Vincent, adding that we should expect a relatively shallow recession in the US.

“The correlation between bonds and stocks [is] high, leaving nowhere to hide. While 2020-2022 has seen some brutal value destruction, expected returns [from companies] have risen. As long-term investors we look forward to taking advantage of these opportunities.”

These opportunities are likely to be found in a range of market segments, from distressed debt through to growth equities.

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While many funds appear overweight US stocks, opportunities are appearing outside the US.

“We are finding more opportunities outside the US than inside, we’re very overweight value stocks,” said Dan Brocklebank, head of the UK executive committee at Orbis Investments.

“The market is worried about recession coming, but we’re invested in quality franchises that have some cyclicality. There are some great long-term opportunities and we’ve been adding to those positions.”

Andrew Headley, head of research at Veritas Asset Management, said the company is focusing on entities that have huge barriers to entry and are cash-generative, such as North American railroads.

Energy companies are also starting to look attractive, with Petrobras in Brazil returning 40% of the share price in the form of dividends, according to Sean Peche of Ranmore Fund Management.

“There’s been up to five years underinvestment in energy, [because] management teams [have] been told by politicians and regulators they don’t want them to exist, yet supply side shortages are going to cause long term problems,” said Brocklebank.

“We’re looking like hawks at what companies are doing with cash flows. If companies like Nestlé are pushing through price increases of 8%, inflation is not transitory.”

• This article originally appeared on Moneyweb and has been republished with permission.