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SIMON BROWN: I’m talking with Dr Adrian Saville of Genera Capital and of course Gibbs Business School. Adrian, always appreciate the time. The talk towards the end of last year was all around a US recession and in fact the debate was would it be a hard or a soft landing? The view seemed to be certain that there would be a recession in the US. We sit here now halfway through the year, and so far no recession. Is it still coming? Is it not coming? What’s your take on this?
ADRIAN SAVILLE: Simon, it’s defying gravity and I guess logic that the US economy in particular has been resilient. I think there are a few things that help us explain, with the benefit of hindsight, what wasn’t as easily seen at the beginning of the year.
Among other things, softer oil and energy prices will have helped. The second thing is that although inflation isn’t tame, it has moderated – especially food price inflation. So I think that that has helped household consumers.
But perhaps the third and the most surprising thing has been the strength of capital markets. The S&P 500 stands out as a case in point with its strongest first half of the year in perhaps the last three decades. That strength back to household balance sheets, along with the relief from lower energy and fuel inflation and food inflation, which cocktail I think has helped stave off certainly a hard recession.
I stay in the boat, though, that recession is on its way.
SIMON BROWN: I take your point. I hadn’t thought of that – if we take it back to the household. If you throw unemployment in there – what’s it, sub-4%? – it means you’ve probably got a job and you’re not worried that you’ll lose your job, because you’ll get another one. So it makes the household confident and ergo out there doing economic activity.
ADRIAN SAVILLE: Look, if you stay in the confines of the US, which is the starting point of our discussion, if we stay inside that framework not only has the economy been relatively strong, but there are sectors that are hiring and perhaps obvious sectors – healthcare, education and government – which continue to spend aggressively, deficit spending. But that doesn’t change the fact that these sectors are resilient and adding jobs.
At the same time it also seems that for recession to happen from a technical perspective the entire economy needs to contract sequentially and in a synchronised way. So you need back-to-back quarters of contraction, and you need broad-based contraction, whereas what seems to be happening is it’s almost as if clusters of the economy are taking turns to recede and then bounce back.
This time last year it was housing that was starting to show signs of anxiety. Amazingly, in the US house building is actually stepping up, notwithstanding the higher interest rates.
SIMON BROWN: You’ve seen that in home builders. You mentioned – we’re talking US – it’s almost like the US is sustaining as an island on its own. In South Africa we might not hit recession but let’s be clear, we’re not growing. Western Europe is really struggling along; the UK is having it really tough. The rest of the world is at risk of recession, very real so, while the US stands as a beacon.
ADRIAN SAVILLE: It might also be the case then that when we step away from the US, as you point out, there are places that are experiencing much tougher circumstances because, along with those factors that we’ve described, the US has also enjoyed a fairly strong dollar which will have helped its cocktail; whereas, as you point out, Western Europe and the UK are in much, much tougher circumstances. The UK looks like it’s going to finish the year in about the same place that it started, and add to that very elevated stubborn inflation, especially food price inflation.
China has slowed quickly. And then, if we bring it all the way back to home circumstances, the South African economy is just having a torrid time. There’s nothing new in that. South Africa really is structurally stuck.
SIMON BROWN: We are structurally stuck. And what this all makes me think is that, notwithstanding you do this, I do this, there’s many of us. The truth is forecasting is hard.
ADRIAN SAVILLE: [Chuckling] Well, I’m making a nonsense of forecasting by starting this conversation and telling you what we couldn’t see [that] at the beginning of this year. Forecasting is notoriously difficult, and we need to be very careful about being emphatic on views and saying this is going to happen with X probability. I think it equips us to think about what scenarios are likely to pan out.
On the balance of probability, I think it is likely that the US heads into recession as we finish the year because, among other things, they’ve got the interest-rate hikes to deal with.
Keep in mind that interest-rate hikes are very blunt instruments and they’re also trailing instruments. So the response to interest rates is with some lag.
What we’re seeing in the US is profit margins are coming under pressure because of the elevated interest rates, and you’ve also got strain in parts, financial strain, so default rates are starting to lift. Now those are trailing indicators and, if anything, I think the Fed is not finished hiking. While they’ve paused, they are not done. Some suggestions are as much as two further hikes by the end of the year. I would say we could be fairly confident that there is at least one more hike, if not two. That’s going to add pain into the equation.
SIMON BROWN: As you’re talking to your point around the forecasting, it does give us a nice model. We need to be flexible with it. Also, when we look back there’s a benefit to it, just [as you were] chatting now. I was in the inflation camp last year, absolutely I was. And now when you talk around it I look at the US consumer and take your point around different parts of the economy picking apart [being] so far wrong. Forecasts actually can help us better in the future forecasts.
ADRIAN SAVILLE: Well, there’s a lovely work done by Philip Tetlock called [Super Forecasting]. You’re familiar with it. We’ve spoken about it before. And one of the things that he points out is, as much as we can hammer ourselves for being wrong in our forecasts, what really equips us is to understand where we were wrong, what part did we miss? And the things that we’ve pointed to, the fact that it looks like the US might be experiencing rolling recession, gives a more nuanced view. And in the same way, incidentally Simon, I think the world might be experiencing a rolling recession.
Chinese recovery happened while the Western European economies were contracting. Now more of Western Europe has gone into recessionary circumstances, but the US is still resilient.
If the US goes into recession late this year, India could do some lifting, and China will start to do some recovery.
So I think that there’s a broader perspective to bring from these lessons that we’ve gathered up in the first half of the year.
SIMON BROWN: It’s a great book and I encourage listeners to go and read it: Super Forecasting. I really, really enjoyed that book.
Dr Adrian Saville, I always appreciate the insights. Thanks very much.
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