With recession worries mounting, it could be time for investors to load up on stocks. Yes, you read that correctly.
Wall Street has worried about a looming recession for much of last year after the Federal Reserve embarked on its path to rapidly raising interest rates to ease inflation that was at multi-decade highs. But while parts of the economy are feeling the sting of a slowing economy — the tech industry has laid off thousands of workers this year — many on Wall Street have come to believe that even a recession might not be as bad as some fear. With recession worries largely baked into the market – barring a sudden shock to the economy – it makes sense for investors to reintroduce riskier assets into their portfolios.
“Recession, meltdown,” wrote Savita Subramanian, equity and quant strategist at BofA Securities, in a note Monday, suggesting investors hold their own stocks over bonds and cyclical stocks over defensive stocks. Hedge funds and long-only funds are near tops in defensive sectors like healthcare, utilities and consumer staples, meaning there’s likely a better risk-reward payoff for cyclical stocks.
That payoff is even more apparent given that the S&P 500, which is currently trading at 20 times forward earnings, looks expensive. But if earnings can hold steady at $50 per share for the next three quarters, the seemingly high multiple could be dismissed as a “valley multiple,” writes Nicholas Colas
,
Co-founder of DataTrek Research.
“This time around, recession chatter is already everywhere and therefore at least somewhat burned into asset prices,” Colas wrote.
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Neither Colas nor Subramanian ruled out the possibility of a slowdown, but they do concede that after raising the federal funds rate from near zero to a range of 4.75% to 5%, the Fed has more room to maneuver around a downturn to mitigate So far over the past year, the economy has grown along with some isolated disruptions like the collapse of Silicon Valley Bank and Signature Bank in March.
“Even if a recession is imminent, the Fed has leeway to mitigate the impact after raising rates by 5%. And after the fastest hike cycle ever, the SVB is the only thing that has been ‘slowed down’ so far,” Subramanian wrote.
Subramanian and Colas aren’t alone in their optimistic thinking. Some corners of Wall Street are confident that there will be no recession and that the very things that make a recession seem likely – the inverted yield curve, inflation and the recent banking crisis – actually guarantee that there will be no recession.
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The inverted yield curve, which occurs when longer-dated bonds have lower yields than short-term debt, has historically been an indicator of a recession, but it’s no longer a good barometer, writes Anatole Kaletsky, chief economist at Gavekal Research. This is due to changes in market structure that are causing bond yields to be set not so much by long-term bond investors as by quants and other more speculative market participants.
“As a result, changes in bond yields no longer anticipate the economic outlook or inflation. Instead, bond yields merely reflect expectations of Fed policy. And Fed policy, in turn, reflects bond yields,” Kaletsky said.
Kaletsky sees falling inflation as evidence of improving supply chains rather than tightening monetary conditions. Kaletsky also dismisses notions that the recent banking crisis are portents of an imminent recession, noting that it will force the Fed to “fixate its inflation target” and eventually pause its monetary tightening, thereby avoiding the economy from collapsing in a recession is being driven.
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All of this should be good news for investors who have been nervous about having money in the market during tough times.
A test for investors comes Thursday when the first-quarter gross domestic product data is released. Wall Street expects the economy to show 2% growth after growing 3.2% and 2.6% in the third and fourth quarters of 2022, respectively. However, the Atlanta Fed’s GDPNow model projects growth of 2.5% for the quarter. A positive surprise can temporarily scare the market but end up better in the long run.
“There is a good chance Thursday’s first quarter GDP report will surprise to the upside. On a side note, this could be bad news for markets on hopes of Fed rate cuts later in 2023,” Colas wrote on Monday.
If so, investors should start looking beyond a recession.
Write to Carleton English at [email protected]
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