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Is a recession coming? Here’s what to watch out for

Markets have taken a sharp knock recently as fears of a recession have grown. John Stepek looks at what’s got them rattled, and how it affects your investment plans.

FTSE share index board at the London Stock Exchange © Luke MacGregor/Bloomberg via Getty Images

The FTSE 100 suffered its worst one-day fall for over three years

A quick note I just want to draw your attention to an event I think some of you might be interested in, particularly if you work in the industry. We have partnered with PIMFA UK for their annual summit on Wednesday 16 October MoneyWeek readers get a discount of 10%, by quoting the code MW10OFF.

Markets had a rough day yesterday.

The FTSE 100 shed more than 3% its worst one-day fall since the start of 2016. Asia is falling this morning, and even the mighty US took a sharp knock, with the S&P 500 ending the day off 1.8%.

It's hardly a return to 2008. But it is rather more turbulent than investors have been used to.

So what's going on?

Markets are worried about weak US economic data

Why are markets rattled? Long story short, recession fear is back.

US economic data has been pretty limp so far this week. Firstly, a key survey of US manufacturing returned its worst figure in a decade, suggesting that activity in the sector is shrinking.

Then yesterday, the ADP private payrolls figure (which gives an estimate of the number of jobs added by the private sector each month) missed expectations, and the figure for the prior month was revised down.

ADP is not usually that big a deal (weirdly, it doesn't have a great correlation with the official US employment data) but with markets already feeling wobbly, and everyone on alert for a turn in the job market, investors paid attention.

So is it all over bar the shouting?

If you're a regular reader, you know I have a tendency to favour caution. Some might even argue that I'm inherently quite bearish.

(I prefer the term "sceptical", but I'll not quibble.)

But let's try to take a look on the bright side, seeing as the market is so keen to do the opposite.

The thing is, the manufacturing sector is important. But it's also a pretty small part of most developed economies these days.

It's also worth remembering, incidentally, that this isn't because manufacturing has shrunk in absolute terms ("we don't make anything anymore" is the plaintive, but generally entirely misinformed cry, you hear any time you bring the sector up).

Factories still produce plenty of goods. They just don't need to employ as many people in doing so. It's just like farming agriculture employs a tiny percentage of the developed world population today, but that's not because we haven't stopped growing food. We just don't need as many people to do it.

Today, providing each other with services to consume has become a far more significant part of the economy. We also keep hearing about how artificial intelligence, big data, and machine learning will eventually disrupt this sector too.

What will we do then? I don't know maybe become space explorers? Builders of artisanal robots? Opinion columnists? Sure we'll find something to do.

Anyway, as UBS pointed out in a note, "the contraction in manufacturing needn't mean the whole US economy slips into recession. Manufacturing represents only around 10% of the US economy."

Also, manufacturing has been slowing for a while. Trade wars aren't helping, but they are a recent problem. It was already hitting a wall.

That's partly about slowing Chinese growth. It's partly about a peak in the current semiconductor cycle (long story short, we've all got smartphones and very few of us are willing to pay £1,000 or more every year for a few go-faster stripes). And it's partly about disruption in car manufacturing (new standards and Germany in particular having trouble adapting to them).

This sector matters more than manufacturing

OK. So it's not good, but it's not an immediate cause for panic. That doesn't mean everything's hunky-dory.

But what really matters is the health of the services sector. US consumers make their money and spend their money in the services sector. Overall, it accounts for the majority of US economic growth (same for the UK).

"Don't bet against the US consumer" is a market saying for a reason. US shoppers are arguably the most potent economic force in the world.

Today we get a reading on the services sector not just in the US but all around the world. And then tomorrow, of course, we get the all important non-farm payrolls figures, which will give us a better view of the health of US workers.

As I said, those figures might disappoint. They might confirm that, actually, we are in trouble. Equally, it's worth remembering that interest rates have fallen in recent months, which means that US mortgages are getting cheaper, which is always helpful for consumers.

Overall, in any case, this shouldn't make much of a difference to your investment plans (just make sure you've got one). But as I've been saying, it's worth understanding why markets are doing what they're doing, so that you can avoid panicking.

Panicking isn't a pleasant feeling. And if you don't panic, sometimes you can spot opportunities that everyone else is missing.

PS I seem to do nothing but tell you about events recently, but if you're in London on Saturday and you fancy seeing some political debate, why not come along and watch me, Iain Dale of LBC and Kari Wilkin of The Week, doing a live recording of The Week Unwrapped podcast with presenter Olly Mann. Get your ticket here.

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