Fears of a recession are mounting as the Federal Reserve prepares to fight inflation. Many stock market investors are already playing in defense and may wonder if these strategies have more room to implement.
But first, how much of a concern is the recession? Google searches for the term have increased significantly, according to trend data from the search giant shown below:
Fear is understandable. Although the labor market remains stable, inflation, which has been at its highest level in four decades, is pushing consumers to landfills, according to sentiment.
Fed plays catch-up
It is clear that the Federal Reserve is belatedly trying to tighten monetary policy at a breakneck pace – including the potential for a multiple, extraordinary increase in interest rates by half a percent. It is also considering closing its balance much faster than in 2017-2019.
Fed officials, of course, say they are confident they can tighten policy and reduce inflation without ruining the economy by achieving what economists call a “soft landing.” There are prominent skeptics, including former Treasury Secretary Larry Summers, whose early warnings of rising inflation proved prophetic.
Keywords: The recession is now the “most likely” outcome for the US economy, not a soft landing, says Larry Summers
The eyes of the curve
And then there is the yield curve.
The yield on 2-year TMUBMUSD02Y treasury bonds, 2.451%, traded briefly above the yield on 10-year TMUBMUSD10Y treasury bonds, 2.829% earlier this month. Prolonged reversal of this measure of the curve is seen as a reliable indicator of recession, although other measures that have proven even more reliable have yet to flirt with inversion.
Read: US recession indicator “still not flashing red”, says the pioneering researcher of the yield curve
The yield curve, even when there is a red code, is not a great indicator of the time for stocks, analysts point out, noting that the period between the onset of the recession and the peak market may last a year or more. However, his behavior attracts attention.
Meanwhile, stocks stumbled over the past week, which was cut to four days until Good Friday, as 10-year government bond yields rose to their highest level since December 2018 mixed start.
You need to know: Risk of default, commodity shocks and other things that investors need to remember as the war in Ukraine enters a new phase
The Dow Jones Industrial Average DJIA fell 0.8 percent, the S&P 500 SPX fell 2.1 percent, and the Nasdaq Composite COMP, heavily weighted by interest-sensitive technologies and other growth stocks, fell 2.6 percent.
Let’s defend ourselves
Although only time will tell if a recession is imminent, the stock market sectors that perform best when economic uncertainty rises are already well ahead of the wider market.
“During periods of macro-uncertainty, some companies / industries perform better simply because they have fewer risky businesses than the average S&P company,” said Nicholas Colas, co-founder of DataTrek Research, in a note on April 14. Large-cap US utilities, basic consumer goods and healthcare – often described as key protection sectors – outperform the S&P 500 SPX, -1.21% this year and in the last 12 months.
The S&P 500 fell 7.8 percent from the beginning of the year to Thursday, while the utilities sector grew 6.3 percent, basic goods rose 2.5 percent and health care fell 1.7 percent.
Colas dived deeper to see if these sectors performed at a normal value for this part of the market cycle. It reviewed 21 years of annual relative return data for each sector, a measure of each group’s performance against the S&P 500 over the previous 253 trading days.
The results:
-
Utilities have recorded an average annual relative performance of the S&P 500 since 2002 of minus 2.8%. The 9.9 percentage point advantage over the last 12 months to Wednesday was just above the standard deviation from the long-term average.
-
Staples has recorded an average annual performance of minus 2.2% over the S&P 500 over the past 21 years. The 7.6 percentage point advantage over the last 12 months was slightly less than a standard deviation from the long-term average.
-
Healthcare averaged an annual average of 0.7% over the S&P 500 in the long term, while the last 12 months of superiority (10.7%) was slightly above the standard deviation from the long-term average.
Running room?
Such stable figures could understandably give the impression that these sectors could be better, Kolas said. But in fact, their superiority has been even stronger in past periods of macro-uncertainty, with all three outperforming the S&P 500 by 15 to 20 percentage points.
“Unless you’re very focused on the US / global economy and corporate profits, we suggest you consider the overweight of these protections,” he wrote. “Yes, they all worked, but they are not overly expanded if the US / global macrophone remains volatile.”
Upcoming attractions
The big banks on Wall Street have offered mixed results to start the profit season, which is in full swing next week. Highlights will include results from electric car maker Tesla Inc. TSLA, -3.66% on Wednesday, with investors also worried about CEO Elon Musk facing distractions as he pursues his bid for Twitter Inc. TWTR, -1.68%.
The economic calendar includes a wealth of housing data early next week, while an anecdotal summary of the Federal Reserve’s beige book will be released on Wednesday afternoon.
Add Comment