Schroders: A recession is on the horizon in the US, how to rebalance the portfolio?
edited by Tina Fung, Strategist, Schroders
While the US economy appears more resilient than expected, the recent turmoil in the banking sector has fueled the debate over whether it was a soft landing or a recession. We lean towards the latter hypothesis and continue to believe it There will be a recession this year, given the rapid pace of rate hikes by the Federal Reserve.
In light of that, How should investors position their investment portfolios to seek shelter from the impending storm of recession? While each downturn is unique and there is no guarantee that history will repeat itself, it is useful to understand how different asset classes have performed during past downturns.
Recessions can be defined by two consecutive quarters of negative real GDP growth or in terms of the business cycle, but here we limit ourselves to US recessions officially dated by the National Bureau of Economic Research (NBER).
Safety first, but be careful not to miss the market reassessment
Recessions are often characterized by a collapse in growth and declining inflation, prompting policymakers to loosen monetary or fiscal policy, or often both. Investors typically seek the safety of government bonds and, to some extent, corporate bonds. The dollar is also seen as a safe haven asset during recessions, especially when the rest of the world is weaker than the US economy. By comparison, stocks and commodities are hit hard by sluggish economic activity.
in general, Over the past 30 years, risky assets have performed worse during recessions, due to the huge losses incurred during the global financial crisis.
While US stocks are always at their lowest levels during recessions, they rebound strongly at the end of the period. The recovery in stocks is due to a combination of cheap valuations and expectations of improvement ahead Economic Activity and Corporate Earnings Thanks to Federal Easing Given the lackluster returns recorded during previous recessions, investors should know that they cannot miss an opportunity to reassess the market.
How did stock sectors perform during previous recessions?
With stocks usually heading into the red during recessions, The most defensive sectors in the US, such as consumer staples and healthcare, had the highest returns on average. That’s because investors sought out companies that offered high profitability and strong balance sheets in times of economic stress.
On the contrary, me The more cyclical sectors of the market, such as the financials and industrials, tend to be the worst performers. However, some sectors that underperformed during recessions, such as real estate and the financial sector, rebounded strongly near the end of the recession.
By comparison, defensive sectors such as utilities tend to post strong gains at the beginning of a recession, but tend to post losses near the end of a recession. Although considered a cyclical sector, the performance of the telecom services sector has also shown this trend during recessions. In fact, prior to 2018, this sector was classified as a defensive sector known as “Telecom”.
The defensive approach pays off, but small caps shouldn’t be ignored
During previous recessions, the most defensive strategies were the winning approach. Investors seem to have turned to high-quality stocks with strong balance sheets and stable cash flows.
in the meantime, Over the past 30 years, the growth pattern has seen more substantial gains during recessions, due to the increasing dominance of technology stocks in the index.
Instead, the worst results were those for small-cap and value-cap stocks. The value pattern is affected by lower interest rates as it is positively correlated with higher government bond yields. While small companies typically have negative returns during recessions, they rise sharply near the end of a recession. It appears that investors are starting to price in the recovery in profitability of smaller companies, as they are likely to benefit from looser monetary policy than their larger peers.
Commodities don’t shine in recessions
Commodities are usually penalized during recessions, and the worst performing sectors are energy and industrial metals, as they are more sensitive to changes in economic growth.
Conversely, gold has tended to shine during recessions as investors relied on its safe-haven status. At the same time, easing monetary policy and cuts in real interest rates usually support gold prices during recessions. but, Strengthening the dollar during recessions is a balancing element.
It should be noted that these results are based on previous recessions in the US and do not take into account China, which is the world’s largest consumer of commodities. For example, China consumes half of the world’s copper consumption and is the second largest consumer of oil. With the US expected to enter recession later this year, growth in China is likely to pick up sharply as restrictions on the zero Covid policy are lifted. The recovery in China is expected to be biased towards services, which could better support the energy sector and partially offset potential drags from the US recession.
While there are no guarantees about the timing of the downturn, we expect it to happen in the second half of this year, which could prompt investors to focus on defensive assets first in the early months of the recession. But they should not ignore the opportunities that emerge as the market reassesses and prepares to move to the next phase of the cycle.
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