Finance

‘Our odd, unconventional recovery could have a shocking result’ — a Wall Street chief strategist explains how the next recession could come out of left field


It’s been a wild, wacky road for the US economy since it bottomed out during the most recent financial crisis.

For one, the recovery has been the slowest-growing in postwar history — failing at seemingly every step to fully win over investors. And while this can be credited with keeping sentiment from overheating, and has perhaps aided the current cycle, it’s been a unique turn of events.

Also, the low-interest-rate environment surrounding the recovery was ultimately an extension of unprecedented quantitative easing on the behalf of the Federal Reserve. Aberrant circumstances often lead to extraordinary measures, and monetary policy is no exception.

These erratic-yet-connected indicators have caught the eye of Jim Paulsen, who serves as the chief investment strategist at Leuthold Group. He’s keeping his eye on conditions he thinks could spur the next economic recession, and what he sees right now scares him.

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“Our odd, unconventional recovery could have a shocking result,” he told Business Insider by phone. “It wouldn’t be at all surprising if the next recession occurred from left field.”

With that established, it’s important to note that an imminent recession is not Paulsen’s base case. Rather, it’s a tail-risk scenario he says could flare up.

Paulsen ultimately foresees the economic expansion being derailed by something that blindsides everyone. If that’s the case, who’s to say it won’t collapse amid the same unprecedented backdrop that built it? That’s precisely his point.

Other late-cycle indicators

Paulsen may still be constructive on the US market in the near term, but the worries in the back of his mind don’t end with the economy’s strange recovery. He’s also keenly aware of the massive amount of money being thrown around by private-equity firms— and the opaque nature of their portfolio holdings worries him.

“You really don’t know a lot about valuations or what their situation really is,” he said. “I wonder if private valuations are much higher than we know, that they’re fairly illiquid, because a lot of it’s done in secret. That gives me some pause.”

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Paulsen also closely watches consumer confidence, which he says can provide valuable hints around when economic expansions are due to roll over. By his logic, a decline in the measure from peak levels signals rough times ahead for the market and a likely rotation into defensive stocks. In other words: late-cycle behavior.

Of course, these are just negative catalysts that could end up trickling their potentially toxic effect into the economy over time. Paulsen can also be more direct with his economic concerns.

In a recent note to clients, the Leuthold CIO outlined six reasons investors should beware a surprise economic shock before the end of the year. They include, among other things, economic data that not only slows but also falls short of expectations.

In the end, the sheer fact that Wall Street experts like Paulsen are so braced for the possibility of an economic meltdown may be a preventive measure, since it’s hard to get caught off-guard by something on your radar.

But they’re just one piece of a much bigger puzzle — one filled with investors not yet ready to give up on the easy market returns they see continuing indefinitely. And until those stubborn parties can be convinced otherwise, the risks loom in the shadows, waiting to strike.

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