Morgan Stanley sees ‘credible bear case’ for a US recession

Interest rate cuts might come too late to save an economy that is dangerously close to slipping into recession, according to Morgan Stanley economists.

“For now, the path to the bear case of a U.S. recession is still narrow, but not unrealistic,” a team led by the firm’s chief U.S. economist, Ellen Zentner, told Morgan Stanley clients in a lengthy analysis that spells out the likelihood of negative growth within the next 12 months and what investors should do if that comes to pass.

Trade tensions that could lead to layoffs and a pullback from consumers are at the center of the recession case. Zentner said the current “credible bear case” probability is about 20%, but that could change quickly.

“If trade tensions escalate further, our economists see the direct impact of tariffs interacting with the indirect effects of tighter financial conditions and other spillovers, potentially leading consumers to retrench,” she wrote. “Corporates may start laying off workers and cutting capex as margins are hit further and uncertainty rises.”

The effects would be a “large demand shock” that would take growth from a projected 2.2% in 2019 to a negative 0.1% in 2020 — a shallow recession but nonetheless a substantial retreat for an economy that grew 2.9% in 2018.

From an investing standpoint, that could mean a significant hit to stocks, with the best bets being defensive sectors like health care and consumer staples, with autos and tech hardware the areas most likely to underperform, according to the analysis.