A Counterpoint to Dour Economic Forecasts

Recession forecasts have dominated financial headlines this year. That is understandable given the global economy’s soft patches (e.g., Europe’s energy situation), and today’s economic headwinds heighten the prospect of recession in certain regions. That said, expectations of a severe global downturn seem overstated, in our view. Fundamental drivers—key among them bank lending—suggest reality isn’t as poor as many anticipate and underpin the recovery we think is coming.

Many prominent outlets and voices think things are going to get worse before they get better. A recent Wall Street Journal survey found a majority of polled economists expect the US will enter recession in the next 12 months. World Bank President David Malpass warned of a “real danger” of a worldwide contraction next year. The International Energy Agency lowered its global oil demand growth forecast because “major institutions” downgraded their latest global GDP estimates.

But the kicker: Last week the IMF’s “World Economic Outlook” (WEO) cranked headlines’ recession warnings into overdrive. Interestingly (and unsurprisingly), most coverage focused on one line in the WEO’s foreword: “In short, the worst is yet to come, and for many people 2023 will feel like a recession.” (boldface ours) We don’t dismiss people’s emotions or hardships, but feelings don’t predict people’s actions. Looking a bit deeper, the IMF isn’t even forecasting a global GDP contraction next year—it is predicting annual growth of 2.7%, 0.2 percentage point below its July WEO estimate. Yes, that is slower growth—but it is still growth.

Now, to be clear: Though we don’t think forecasts are assured to prove prescient, they don’t seem completely off base, either. For example, among major economies, the IMF forecasts annual GDP contractions in Germany, Italy and Russia next year. In the IMF’s view, the Continent’s high energy prices will knock the first two due to their reliance on natural gas—and for Germany in particular, due to its dependency on Russian energy. Russia’s projected contraction is tied to economic sanctions due to its despicable invasion of Ukraine. We wouldn’t be surprised if those estimates held up, as we have seen evidence of soft patches in Europe and other parts of the global economy and German industry is uniquely dependent on petrochemical feedstocks. However, while a shallow recession is possible, global stocks’ behavior this year implies they have been digesting these prospects for a while. This is how forward-looking markets work: They don’t wait for official confirmation of recession. Rather, they pre-price probabilities and move on. 

In our view, economic forecasts have value for investors, but not because they are crystal balls. Rather, they provide a useful snapshot of sentiment. Forecasts reveal supranational organizations’ views, which can influence others’ opinions, including other research outfits, policymakers, commentators and investors. The reaction to popular, widely followed forecasts also reveals insight about people’s feelings. This combination sets baseline expectations—critical information for investors as they assess how outlooks square with reality.

On that reality front, economic fundamentals argue against a deep, severe recession, in our view—and firm loan growth in major developed economies is one telling piece of evidence. Consider: America’s biggest banks recently reported Q3 earnings, and we have seen myriad analysts scour the numbers to paint a picture about the US economy. Similar to the chorus of concerns tied to recent global economic forecasts, many focused on weak spots (cooling mortgage lending due to rising rates) or dour outlooks (e.g., bank executives’ recession concerns).

But this negative focus overshadowed some positive news in banks’ bread and butter business: lending. America’s big banks reported brisk Q3 loan growth, which brought in more interest income. This isn’t a blip, either. Lending has picked up over the past 12 months. (Exhibit 1)

Exhibit 1: US Lending Has Been Picking Up

Source: St. Louis Federal Reserve, as of 10/18/2022. Loans and leases in bank credit for all commercial banks, in billions of USD, seasonally adjusted, monthly, September 2015 – September 2022.

Outside America, loan growth has also picked up in other major developed nations, albeit at slower rates. (Exhibit 2)

Exhibit 2: Loan Growth Is Up in the UK, Eurozone and Japan, Too

Source: European Central Bank, Bank of Japan and Bank of England, as of 10/11/2022. August 2015 – August 2022. HT: Fisher Investments Research Analyst Shayan Saeri.

Loan growth implies money is flowing to businesses, which can underpin investment in growth-oriented endeavors. US nonresidential private investment (i.e., business investment) suggests this has been happening, as the measure rose 7.9% annualized in Q1 and 0.1% in Q2.^[i] Note: These numbers are adjusted for inflation, so though investment may have slowed due to elevated prices, it didn’t crater, either. Moreover, Q2’s headline business investment figure doesn’t tell the whole story. On a category basis, a double-digit contraction in structures investment (-12.7% annualized after Q1’s -4.3%) detracted most.^[ii] Equipment spending didn’t slide as drastically (from Q1’s 11.4% to Q2’s -2.0%) and intellectual property products spending remained steady (10.8% in Q1, 8.9% in Q2).^[iii] If a deep recession loomed, we would expect to see investment plunge broadly, and we don’t see that in these data.

Looking to the more recent past, the St. Louis Federal Reserve Real GDP Nowcast—a compilation of incoming data that comprise GDP—points to 1.2% annualized growth in Q3.^[iv] The Atlanta Fed’s “GDP Nowcast” projects a stronger number: 2.9% annualized Q3 growth (and 5.1% growth in business investment).^[v] These nowcasts aren’t ironclad, and they will shift and change as data arrive. And no Q3 data are likely make-or-break for markets, which tend to look further out. But given that pessimists have been saying worse lies ahead month after month this year, we figure a result approximating those figures would highlight how excessively dour many observers are these days. Again, that isn’t assured. But maybe, just maybe, keep an eye on it.

Lending isn’t the only positive. Others include easing supply chain pressures and gridlocked politics in many developed nations. While the pessimism of disbelief dominates now, low expectations mean reality has a low bar to clear. For investors, stocks don’t need perfection to rise—better-than-expected is the grounds for a recovery.