A look-back at the global economy: The upswing before the downturn

Advanced equity market cycles often create good returns. Although the momentum of the global economy is slowing down and suggesting an imminent recession, there are valid reasons to have patience with equities. We look at past and future developments. 

Risk premiums on stocks rise before a recession

An interesting phenomenon: Equity markets often perform well above average one to three years before a recession. Why? It's hard to say. There are many hypotheses. Perhaps efficient markets simply demand higher risk premiums the closer we get to a recession. Because when the proverbial music finally stops, the way out often becomes crowded.

Let's briefly look at the historical total returns (price gains plus dividend yields) of US and Swiss equities before recessions. We see that the late stages of a bull market are historically some of the best.

Performances of various investments before the beginning of a bear market

Government bonds  Switzerland US
12 months before + 2.1% + 3.9%
24 to 12 months before + 2.9% + 6.3%
36 to 24 months before + 2.3% + 5.2%
Small and mid caps    
12 months before + 29.1% + 36.4%
24 to 12 months before + 14.0% + 13.7%
36 to 24 months before + 8.9% + 18.5%
Large caps    
12 months before + 14.6% + 24.2%
24 to 12 months before + 9.8% + 14.4%
36 to 24 months before + 10.7% + 14.2%

Data period: 1927 to 2007

Source: NBER, Wells Fargo Investment Institute, Credit Suisse Financial Market Yearbook Database

Past performance and financial market scenarios are not reliable indicators of future results.

The global economy goes through four economic phases

It's clear that there are almost always typical "winners" in the four schematic economic phases of "broad upturn," "slowdown," "recession," and "recovery." 


The four economic phases of the world economy

The "exchange clock" shows how the economy and stock markets are schematically related Source: Credit Suisse

Which phase are we in right now? We are probably on the threshold between a very strong upturn and a slowdown in the momentum of the world economy. The revised growth estimates for the next five years demonstrate this:


Global economic growth – review and outlook

Source: Credit Suisse Capital Market Assumptions, November 2018 Update

The global economy is not yet facing a "paradigm shift"

Most stock market bubbles burst when reports circulate about a forthcoming "paradigm shift." In the late 1960s, investors euphorically sought equities with qualitatively strong growth. At the same time, the US succeeded in the first moon landing and the US economy expanded on average almost 4.9 percent per year between 1959 and 1968. But at the end of this period, the valuations were so high that equity risk premiums no longer offered investors useful compensation. The market had generated a speculative bubble fed by future hopes that could not be fulfilled – one that finally burst.

The dot-com bubble also ended in March 2000 – just as the media were positively full of reports on a technological-social paradigm shift. But let's not get carried away: Currently, growth stocks globally are trading at a price-earnings ratio (P/E ratio) of 25x and tech stocks at a P/E ratio of 15.8x. The average P/E ratios of most emerging markets, including China, are single digit. For example, the Hang Seng Index is trading at a P/E ratio of 9.8x. The EuroStoxx 50 yields a P/E ratio of 13.8x. This is a valuation that leaves room for upward movement in the medium term, not only in absolute terms, but also in relative terms, i.e. in comparison to today's interest rates, which are disproportionately lower than in 2000 or 1968. 

We expect a recession at the earliest at the end of 2020.

Burkhard Varnholt

Falling equity markets often go hand in hand with recessions

With the exception of the stock market crisis in October 1987, all previous US bear markets went hand in hand with recessions: That was the case from November 1968 to May 1970, from January 1973 to October 1974, November 1980 to August 1982, July 1989 to October 1990, March 2000 to October 2002, and from October 2007 to March 2009. Falling stock markets begin an average of eight months before the start of the recession.

That brings to mind the earlier question of when we expect the next recession. The answer is: In our mid-term baseline scenario, we do not expect a recession in any of the major economic areas – the US, China, and Europe – in the next few years. In our negative scenario, a recession would be plausible at the earliest at the end of 2020, but more likely in 2021.