Fears of a recession are mounting as the Federal Reserve gears up to fight inflation. Many stock market investors are already on the defensive and may wonder if those strategies have more room to run.
But first, how worrisome is a recession? Google searches for the term are booming, according to trend data from the search giant below:
The fear is understandable. While the job market remains robust, inflation reaching a four-decade high has left consumers in trouble, according to sentiment readings.
Fed is catching up
It can be seen that the Federal Reserve is trying too late to tighten monetary policy at breakneck speed — including the potential for multiple, outrageous, half-a-point hikes in interest rates. It is also considering a much faster winding-down of its balance sheet than in 2017-2019.
Fed officials, of course, say they are confident they can tighten policy and drive down inflation without crashing the economy, achieving what economists call a “soft landing.” There are prominent skeptics, including former Treasury Secretary Larry Summers, whose early warnings of rising inflation have proved prescient.
Keywords: Recession is now ‘most likely’ outcome for US economy, not a soft landing, says Larry Summers
Eyes on the bend
And then there’s the yield curve.
The return on the 2-year Treasury TMUBMUSD02Y,
2.451%
traded briefly above the 10-year Treasury yield TMUBMUSD10Y,
2.829%
earlier this month. A more prolonged inversion of that measure of the curve is seen as a reliable recession indicator, although other measures that have proved even more reliable are not yet flirting with inversion.
Read: US recession indicator ‘not yet flashing code red’, says trailblazing yield curve researcher
The yield curve, even if this code is flashing red, isn’t much of a timing indicator for stocks, analysts have emphasized, noting that the period between the start of the recession, as well as a market peak, can last a year or more. Still, his behavior gets attention.
Share prices, meanwhile, tumbled over the past week, which was shortened to four days on Good Friday, as 10-year government bond yields soared to their highest level since December 2018, Russia’s brutal invasion of Ukraine continued and major banks turned the earnings season into one. brought to an end. mixed start.
Must know: Default risk, commodity shocks and other things to keep in mind for investors as the war in Ukraine enters a new phase
The Dow Jones Industrial Average DJIA fell 0.8%, the S&P 500 SPX lost 2.1% and the Nasdaq Composite COMP, heavily weighted in interest-rate sensitive technology and other growth stocks, fell 2.6%.
get defensive
While only time will tell whether a recession is on the horizon, stock market sectors that perform best when economic uncertainty is mounting have already outperformed the broader market significantly.
“During periods of macro uncertainty, some companies/sectors perform better because they have less risky companies than the average S&P firm,” Nicholas Colas, co-founder of DataTrek Research, said in a note dated April 14. US large-cap utilities, consumer discretionary and healthcare — often described as the top defensive sectors — all outperform the S&P 500 SPX,
-1.21%
this year and in the past 12 months.
The S&P 500 through Thursday was down 7.8% since the start of the year, while the utilities sector rose 6.3%, commodities were up 2.5% and healthcare fell 1.7%.
Colas delved deeper into whether those sectors were performing a normal amount during this part of a market cycle. He looked at 21 years of annualized relative return data for each sector, a measure of how each group performed against the S&P 500 over the previous 253 trading days.
The results:
-
Utilities saw an average annualized relative performance against the S&P 500 from 2002 to present of minus 2.8%. The 12-month outperformance of 9.9 percentage points through Wednesday was just over one standard deviation from the long-term average.
-
Staples saw an average annualized performance of minus 2.2% against the S&P 500 over the past 21 years. The outperformance of 7.6 percentage points over the past 12 months was just under one standard deviation from the long-term average.
-
Healthcare saw an average long-term outperformance of 0.7% yoy against the S&P 500, while the last 12-month outperformance (10.7%) was just over one standard deviation from the long-term average.
Room to run?
Such robust numbers can understandably give the impression that those sectors may be outperforming, Colas said. In fact, their outperformance has been even stronger during past periods of macro uncertainty, with all three outperforming the S&P 500 by 15 to 20 percentage points.
“Unless you are very optimistic about the US/global economy and corporate earnings, we recommend that you consider these defensive groups,” he wrote. “Yes, they have all worked, but they are not yet overstretched if the macro background in the US and the world remains volatile.”
Upcoming attractions
Big Wall Street banks offered a medley of results to kick off the earnings season, which will be in full swing into the coming week. Highlights include the results of electric car manufacturer Tesla Inc. TSLA,
-3.66%
on Wednesday, as investors also worry whether Chief Executive Elon Musk will face distractions as he makes his bid for Twitter Inc. TWTR pursues,
-1.68%†
The economic calendar features a host of housing data early in the coming week, while the anecdotal summary of the Federal Reserve’s economic conditions appears in the Beige Book on Wednesday afternoon.