The U.S. economy stands a 31% chance of double-dipping into recession in the next year.
That's the average of the predictions by economists, CEOs, chief investment officers, portfolio managers and chief strategists of some of the world's largest traditional and hedge fund managers. Collectively, their companies manage $7.2 trillion.
Despite an Aug. 27 promise by Federal Reserve Chairman Ben S. Bernanke that the U.S. central bank “will do all that it can” to keep the country's economic recovery on track, negative sentiment ran high among the 16 senior money management executives invited by Pensions & Investments to give their views.
The vast majority put the odds of a double dip during the next 12 months at 25% or higher. Just 21% said the chance was 20% or less. Two sources declined to make a prediction.
Many well-known investment executives, particularly those from hedge fund firms, declined to be interviewed. That reluctance is testimony to the level of anxiety within the money management industry and the reluctance of some to publicize their thoughts on the near-term economic future, sources said.
Joseph H. Davis, chief economist and head of the investment strategy group at Vanguard Group, Malvern, Pa., said his 35% prediction of a double-dip recession “is uncomfortably high. I've rarely seen the chances of a double dip this high at this stage of a recovery.”
Mr. Davis said Vanguard has warned its clients that the recovery will be protracted, “one of the most drawn out since the 1870s, with the exception of the Great Depression.”
He added: “There is a fraying at the edges of confidence. Confidence is the link between falling and recovery. Business investment is the single most important linchpin for recovery. There are huge corporate profit margins, cash levels are very high. Businesses have the capability to hire, but the question is whether they have the inclination, given the lack of regulatory clarity.”
Vanguard managed $1.4 trillion as of June 30.
The most bearish prediction — “way over 50%” chance of a double dip — came from Robert Arnott, chairman of Research Affiliates LLC, Newport Beach, Calif.
Robert L. Reynolds, president and CEO of Boston-based Putnam Investments, was the most optimistic, putting the odds at just 10%.
GDP to fall
Mr. Arnott is convinced that U.S. gross domestic product will drop and plunge the U.S. back into a recession before the end of the year. “I'm highly disappointed at the high odds of a second recession, which was entirely preventable through policy moves,” he said.
As of June 30, Research Affiliates managed $3 billion internally; another $50 billion was managed by external money managers licensing the firm's investment strategies.
Mr. Reynolds, by contrast, looks at the current environment as a good buying opportunity. The record level of U.S. corporate profits is leading Putnam's equity strategy managers to be “very bullish. Stocks are cheap now and the market waits for no one.” Still, Mr. Reynolds said stock portfolios contain a little more cash than usual and are concentrated on higher-quality securities.
On the bond side, Putnam has been reducing durations “because interest rates can only go up from these levels, although that's probably not imminent. Our managers are going for more high-quality bonds, especially in high yield.”
Putnam managed $115 billion as of July 31.
Philip A. Falcone, CEO and founder of hedge fund firm Harbinger Capital Partners LLC, New York, put the odds of the U.S. economy double-dipping at 25%.
“This may be one of the toughest parlor games around,” Mr. Falcone said in an e-mailed response to questions. “The macro picture in the U.S. feels balanced around a "flat-ish' GDP rate of change. Unemployment appears to have bottomed at a level that challenges growth and now looks as though it isn't likely to move much in either direction in the short term. Political and regulatory uncertainty is restraining corporate America's appetite to deploy very significant cash balances, muting `private sector stimulus.'”
Harbinger managed $9 billion in its family of multistrategy hedge funds as of June 30.
Like Mr. Falcone, Mohamed A. El-Erian, CEO of Pacific Investment Management Co., LLC, Newport Beach, Calif., puts the chance of a second recession at 25%, and says it's “a meaningful number.”
The U.S. economy suffered “a weak handoff, it was only partially successful” after the “temporary sources of growth, such as the stimulus package” spurred growth last year, he said in an interview. To avoid another recession, Mr. El-Erian said “growth has to be fast. Part of the economy's fragility is the speed of the economy. It's at stall speed now and it needs to move much faster for recovery to really take hold.”
PIMCO managed $1.1 trillion as of June 30.
But Robert Doll, vice chairman and chief equity strategist, BlackRock Inc., New York, predicted a 20% to 25% chance of a double dip, which he says is “not very high.”
“Double dips are very rare. History shows that to repeat a recession, you usually have to hit the economy over the head with a two-by-four. Something like a crisis in the Middle East that would cause oil prices to rise sharply, for example,” Mr. Doll said in an interview. BlackRock managed $3.2 trillion as of June 30.
Modest impact
The consensus of the staff at alternatives manager Bridgewater Associates LP, Westport Conn., was 40% odds of a double dip, said Greg Jensen, co-CEO and co-chief investment officer.
But whether a recession occurs probably doesn't matter, he said.
“We don't think it's particularly important to markets or the economy whether technically we fall into a double-dip recession, as the difference between the very weak growth we expect and negative growth is modest in its impact,” he wrote in an e-mail. “We suspect growth will be right about 1% and given the reliability of such estimates, the odds that growth is outright negative are probably about 40%. Either way, the level of economic activity will be well short of capacity for a very long time.”
Bridgewater managed $81 billion as of Aug. 1.
Hedge fund manager Marc Lasry, chairman, CEO and co-founder of Avenue Capital Group, New York, is much less pessimistic, predicting the chance of a second U.S recession at “about 10%, maybe 20%. Not high.”
“Everyone makes it sounds like this is rocket science, but solving the problem is very simple. Banks have been buying T-bills. If they weren't, they'd be issuing more capital. The Fed should limit the amount of T-bills banks can buy, but they've been worried about the real estate loans in their portfolios. Sooner or later, the Fed will have to decide that it doesn't want to protect banks' real estate loans and will limit T-bills, and then banks will loosen up the capital for lending,” Mr. Lasry said.
Avenue Capital managed $18.2 billion in its family of multistrategy hedge funds as of June 30.
Steve Walsh, CIO of Western Asset Management Co., Pasadena, Calif., said his firm is “in the recovery camp” and put the chances of a double dip at 10% to 12%.
“When you're so close to a near-death experience like we were in 2008, it's easy to get pessimistic again very quickly. There is just so much lingering pessimism out there right now,” Mr. Walsh said.
But he believes there is a 10% to 12% chance of a double-dip recession because “it's our belief that monetary policy is extremely accommodating and will remain so. The full force of monetary policy is at work: zero interest rates; the Treasury purchasing more debt; and a steep yield curve. These conditions seldom yield a double dip. The Fed is not fighting this. It will do everything it can to prevent a double dip.” WAMCO managed $460 billion in fixed income as of June 30.
Countering that optimism, hedge fund manager Richard L. Chilton Jr. put the chance that the U.S. economy will have two quarters of negative GDP growth between 30% and 40%.
“My comments are predicated on the fact that everything is precariously balanced on a knife's edge right now. A policy decision of any kind could tip the economy either way. The economic situation is like a giant Rubik's Cube; all the factors are so interrelated,” he said. Mr. Chilton is chairman, CEO and CIO of Chilton Investment Co. LLC, Stamford, Conn., which managed $6 billion in multistrategy hedge funds as of June 30.
Growing risks
For portfolio manager Kathleen Gaffney, who co-manages the $19 billion Loomis Sayles Bond fund, “the risks are increasing every day. The stimulus is gone, inventory restocking is over, there are fears of contagion from sovereign debt problems in Europe. It's constantly `risk on, risk off' in this economy. There's adequate liquidity, but it's not going anywhere and the economy is stagnating.”
She put the odds of a double-dip recession at 40%. “I want plenty of liquidity now, primarily in non-dollar securities. Corporate bonds offer good value, but you have to be up on the capital structure.”
Said Vadim Zlotnikov, chief market strategist, AllianceBernstein LP, New York: “Liquidity is out there, there's pent-up demand for capital equipment expenditures, but corporations continue to sit on cash. This is a commentary about uncertainty.
Mr. Zlotnikov put the chances of a double dip between 33% and 35%. He said U.S. corporations also are suffering from “a perceived lack of pricing power. The fear of deflation has gripped many industries, and managers out there are wondering, "Can I raise my prices to reflect the higher costs I'm paying to my suppliers?'”
“Corporations have record-high profit margins now, mostly from cost cutting. If they had confidence in volume flow for the sale of their goods, they'd spend more, hire more people. But because businesses can't rely on volume they need to rely on pricing, and their lack of confidence about their pricing power is inhibiting their expansion.”
The value-oriented co-managers of the $97 million Ariel Focus Fund, Charles K. Bobrinskoy and Timothy Fidler, say the U.S. stands a 25% chance of dipping into a recession.
While “recent market weakness is signaling heightened concerns about a double-dip recession ... that doesn't mean there will be one,” the pair wrote in an e-mailed response to questions. “Furthermore, the recovery in market valuations off the bottom was as violent to the upside as it was in the collapse that ended in March 2009. That said, investors with a bit of patience should like what they see right now. The economy will eventually recover fully and the prices investors can pay right now for equities will look like bargains a few years out.”
Mr. Bobrinskoy is vice chairman and director of research; Mr. Fidler is senior vice president at Ariel Investments LLC, Chicago. Ariel managed $4.8 billion as of July 31.
Christine WIlliamson is a reporter for sister publication, Pensions & Investments
