Where to invest if a 'deep and long' recession happens

Villamin has revised his outlook downwards for most asset classes, as he said he expected a technical recession in most developed countries in the coming quarters. 

A technical recession is defined as two consecutive quarters of negative GDP growth, something which has already happened in the US. 

But Villamin says a more pronounced downturn could happen in Europe. He said: “The UK and the eurozone are the most exposed to the energy crisis, while inflation has not yet peaked leaving central banks forced to move interest rates into more restrictive territory.

Activity in China should benefit from renewed fiscal and monetary measures.Norman Villamin, Union Bancaire Privée

"Activity should contract in the quarters ahead and could well be depressed until Q2-23.

"Risks of rationing of gas and electricity during the winter are significant, despite governments’ efforts to save energy and to cap gas and electricity prices with renewed targeted supports.”

He said the increased vulnerability of European economies to higher energy prices mean central banks must not simply increase rates to the neutral level that is usually the target of central bank policy, but actually to a level above that, to actively reduce growth in those economies. 

Villamin added that monetary policy action has likely come at the same time that economic growth would be slowing anyway, as a result of the higher energy prices.

However, he said he believed central banks would not “pivot” away from rate rises, despite the slowing economy.

This is largely because inflation will remain higher than target well into 2023, and because the lesson of the 1970s was that it takes materially higher interest rates for a prolonged period of time in order to tame inflation.

Simon Gergel, manager of the £658m Merchants investment trust, said the key determinant of interest rates globally will be the actions of the US Federal Reserve, as other central banks must largely act in tandem with that central bank. 

In terms of what all of this means for investors, Villamin said he has added US government bonds, particularly longer-duration assets, as the yields now look attractive. In the equities space, he says the risks remain elevated and so he is cautious, but he positive on Asia.

Villamin said: “Activity in China should benefit from renewed fiscal and monetary measures expected after the next Party Congress in October. As a result, 2023 growth should reach 5.2 per cent as headwinds from Covid policy and the property sector should be less of a drag.

"Asian countries should see 4.2 per cent aggregate growth in 2023 as positive demographic trends and sound fundamentals help to enable the region to grow despite USD strength and rises in key rates in 2022.” 

According to Gergel, there has been an element of “forced selling” in the UK equity market, particularly in the mid- and small-cap part of the market, and this may represent an opportunity. 

This was echoed by Rupert Thompson, market strategist at Kingswood, who said much of the bad news has already been priced into equities.

david.thorpe@ft.com