The next recession is still a long way off – 5 reasons

When will the expansion end? Isn't the next recession already long overdue? Many investors are asking this question with growing concern. But they are overlooking one fact: Expansions don't die of old age, but of overheating. The longest expansion to date lasted 26 years. And the current one appears stable in historical comparison.

Business cycles can last some time

Many investors are wondering where we currently are in the business cycle. Some think the current expansion has had a suspiciously long life. That's understandable. But it is also worth noting that investors ask much more frequently when the next recession will occur than whether this expansion could be one of the longest lasting in history. Does the fear of healthy realism sometimes dominate when people make investments?

First things first:

  • We think it is very unlikely that there will be a recession in the next two years.
  • The longevity of the current expansion is not unusual. Australia's economy has expanded for at least 26 years without recession. 
  • Overheating, not old age, is the most common early warning sign for recessions.
  • Despite bottlenecks, we do not see any systemic overheating in interest rates, inflation, debt servicing, or investments.
  • Equities have regularly performed best in comparable economic phases.

The growth marathon: Consistency beats speed

Recent composite economic indicator: Recoveries and expansions
Source: Yardeni Research, Conference Board, Haver Analytics

5 reasons the business cycle will continue

Business cycles behave the way nature does: If you save your strength, your condition improves. This actually describes the simple secret of the continuing expansion of the global economy since 2009. The economy is a marathon runner, not a sprinter. However, in view of the renewed volatility of the financial markets, it seems appropriate to look at the key "early warning indicators" for recessions:

1. Yield curves are positive

Inverted yield curves have pointed to virtually all recessions of the past fifty years on average eleven months before they occurred. That means that when long-term interest rates fell below the level of short-term interest rates, a recession usually followed a year later. This is because a negative yield curve reflects both a tight money market situation and dwindling investment opportunities. Both are early signs of economic difficulties.

Yield curves are currently still positive, although they are flatter than before. The "Recession Forecasting Model" of the New York Federal Reserve Bank, which has predicted every US recession since 1962, suggests that there is a 0 percent probability of a recession in the US in the next 12 months. In any case, our economists do not expect an inversion of the USD yield curve before the third quarter of 2019. In other words, this would suggest a recessionary end to the current expansion at the earliest in two years, i.e. towards the end of 2020.


Bond markets estimate the probability of a recession in one year at zero

Probability of a recession in the next 12 months (recession periods highlighted in light blue)
Source: Credit Suisse Research, Thomson Reuters

2. The economy is showing few signs of overheating

If an economy overheats, negative feedback loops can arise from inflation, monetary policy, indebtedness, investment and, not least, collective fear. These negative feedback loops are difficult to control. They caused recessions in the US in 2007, 2001, 1990, 1980, and 1973.

Three early warning indicators at a glance

Early warning indicator: overheating Average lead time to past recessions Current assessment
Capacity reserves disappear 27 months Only partially, but not precariously
Full employment 33 months In many places
Average wage growth > 3.5% 9 months No

Source: Credit Suisse

By way of illustration: According to our estimates, nominal wages in Switzerland rose by 0.7 percent last year despite full employment. Precarious bottlenecks are rare. Trade unions have lost power. Management functions are also being streamlined. In short, the threat of overheating and a negative feedback loop appears low.

3. Profit margins have not yet peaked

Historically, recessions have followed about 30 months after profit margins peak. Our strategists do not expect profit margins to peak until next year. But even if the profit margins had already peaked, statistically this would not suggest a recession until the end of 2020.

4. Debt servicing is low

When debtors begin to restructure their balance sheets, recession follows on average 24 months later. However, although debt has grown in recent years, debt servicing is also low thanks to low interest rates. Free cash flows are also significantly higher worldwide than the total of debt servicing, dividend payments, and capital repurchases.

5. No discernible overinvestment

A recession is often preceded by a paradigm shift. But exaggerated corporate investments, the proverbial "bridges to nowhere," are currently few and far between. In short, if developments in the past are an indicator, the next recession will not occur until the end of 2020 at the earliest.

When will the next recession occur?

Early warning indicator Date of occurrence Number of months until recession Implied recession date
Inverted yield curve Q2 2019 (E) 12 Q2 2020
General capacity bottlenecks Q1 2019 (E) 27 Q2 2020
Overheated labor market Q3 2017 33 Q1 2020
Wage growth > 3.5% (USA) Q4 2019 (E) 9 Q3 2020
Irrational investment boom Q2 2020 (E) 3 Q3 2020
Corporate financing deficit Q1 2019 (E) 24 Q1 2021
Peak in profit margins Q1 2019 (E) 30 Q3 2021

Source: Credit Suisse

Conclusion: Equities remain the most attractive asset class

If, as we expect, the expansion continues for another two years, then there is still much to be said for equities. This is because, historically, equities only correct eight months before the onset of a recession.

In the 12 to 18 months before the onset of a recession, equities rose by an average of 9.2%. In the 6 to 12 months before a recession, share prices rose by an average of 8 percent – with only one exception, the 1973 oil crisis; in two-thirds of all cases, equities fell only in the six months before a recession.

S&P 500 performance before the start of a recession

18 – 12 months before the onset of a recession, equities are often bullish

Start of recession 6 months before 12 – 6 months before 18 – 12 months before
Nov. 1973 –0.7% –3.8% +18%
Jan. 1980 +5.8% +6.1% +0.6%
Jul. 1981 –4.1% +17.7% +6.5%
Jul. 1990 +2.1% +9.7% +15.4%
Mar. 2001 –17.4% +8.9% +4.5%
Dec. 2007  –3.2% +9.3% +10.3%
Average –2.9% +8.0% +9.2%

Source: Thomson Reuters, Credit Suisse Research
Historical performance and financial market scenarios are not reliable indicators of future results.