A US Recession Will Initially Drag Global Equities Lower

``Recessions are not caused by a general shortfall in spending, but instead by a mismatch between the mix of goods and services supplied by the economy and the mix of goods and services demanded. Though demand shifts away from some kinds of output that the economy produced in the prior expansion (as we saw with tech and telecom in 2000-2002 and are seeing in housing today), we often see continued demand in other sectors, but the mismatch takes time to correct, and output and employment suffer as a result. Most job losses during a recession are typically concentrated in a small number of industries, while other industries experience growth and even growing backlogs and rising employment. So the next recession, whenever it occurs, will probably feature a good amount of dispersion. Most likely, we'll observe particular weakness in housing-related industries (and associated finance sectors), while a variety of sectors including technology, oil services, broadband telecommunications, and consumer staples may be better situated (though such stability still may not prevent stock price weakness).”- John Hussman, Hussman Funds

How does a US recession affect world equity markets?

Learning from the past using the 2000 model we can take note that global equity markets echoed the directional path of the US markets as shown in figure 3.

Figure 3: US 2000 Bubble Implosion Reverberated in Asian Markets

Where the US Tech bubble crashed in 2000 as shown in Figure 3 (see red line), the plight of the Philippine benchmark, the Phisix (shown by the black candle), which was in a bear market in the aftermath of the 1997 Asian Crisis, was further aggravated until it reached its trough in 2002.

The 1998-1999 cyclical rally amidst a secular bear market was mostly due to the reaction as a natural consequence to the violent 1997 selloff and in confluence to the seasonal “New President’s stockmarket honeymoon” following the Presidential election victory of Joseph E. Estrada.

As you can see, no trend goes in a straight line. And secular trends are usually pockmarked by intermittent cyclical countertrend movements or plainly said, a cyclical bear market amidst a bullmarket or a cyclical bullmarket amidst a bearmarket. 1998-1999 signified the latter.

Notice too, that Asian markets represented by Japan’s Nikkei (green line), Hong Kong’s Hang Seng (gold line) and Singapore’s Strait Times (blue line) all turned lower or inflected by 2000, stayed on a general declining trend for more than a year then bottomed out synchronically by 2002.

So if the past were to do an asymmetric reprise, then a US recession could likely lead to a similar decline in Asian markets, including our Phisix…initially.