Trading Strategies for Investors Worried About Rising Recession Risks
Countries like the United States and the United Kingdom are struggling with inflation that has reached multi-year highs as the war in Ukraine has caused energy prices to soar and food prices to rise.
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Talk of a recession is heating up, with Wall Street veterans pointing to growing risks of a downturn — and offering advice on how to invest during this cycle.
Investment bank Morgan Stanley said that while a recession is not its base case, it is its bearish case because the risk of a recession has “significantly increased”.
“Needless to say, there are many shocks hitting the economy right now that could tip us into a recession at some point over the next 12 months,” the investment bank said in a May report. He cited factors such as an escalation in the Russian-Ukrainian war that could push oil prices to $150, an extremely strong dollar and crushing pressures on business costs.
Wall Street veteran Ed Yardeni, who in April said there was a 30% chance of a recession, raised that figure to 40% last week, while Citi CEO Jane Fraser told CNBC that she was convinced that Europe was headed for a recession.
The war in Ukraine has caused energy prices to soar and food prices to rise. The United States and the United Kingdom – and other countries around the world – are grappling with inflation that has reached multi-year highs.
Major stock indices have seen steep declines since peaking in late 2021 and early this year, with the Nasdaq losing around 23% since the start of 2022. The S&P 500 has fallen around 13% over the same period.
Here’s how anxious investors can ride out ongoing stock market turbulence, experts say.
While volatility is expected to persist, Morgan Stanley recommended defensive sectors in a May 16 report on its US market outlook. These include health care, utilities and real estate.
“With the exception of energy, all of the best performing sectors came from the defensive end of the spectrum,” wrote Morgan Stanley. “We don’t think defensive stocks will perform very well in absolute terms, but they should offer some relative protection, as our call for lower earnings and multiples would hit cyclical stocks harder.”
Defensive stocks provide stable dividends and earnings regardless of the state of the overall stock market, while cyclical stocks are stocks that can be affected by the cycle of the economy.
Here’s what Morgan Stanley says about the three defensive sectors:
- Health care: The sector is trading at a discount to the broad market, unlike most other defensive sectors, according to Morgan Stanley. The bank prefers large-cap stocks in the pharmaceutical and biotech sectors, adding that they trade at an attractive price and offer relatively attractive dividend yields.
- Immovable: The sector gained 42% last year and outperformed the broader US market by 16%, Morgan Stanley said. The bank likes this sector for its stable earnings and dividend income.
“Stable cash flows within REITS should provide defensive exposure against market declines over the coming year,” Morgan Stanley said.
“Furthermore, REITs provide built-in inflation protection through leases, rent increases and real estate appreciation which should allow the sector to weather the high inflationary environment relatively better than other sectors,” he added.
- Utilities: Valuations are already high, but Morgan Stanley is more bullish on this sector for its downside protection, as opposed to any other upside.
“With nearly every industry facing the effects of rising energy costs, the established pricing structure within utilities should provide relative protection in this high cost environment,” he said.
A recession “requires extra patience” in deploying cash for any investment opportunity, Wells Fargo Investment Institute said.
Sameer Samana, senior global market strategist at the advisory firm, told CNBC that investors should “slow down” their pace of reinvestment because bear markets can last around a year and sometimes cause declines of around 30% .
“Long-term investors typically diversify for times like these,” added Scott Wren, senior global market strategist, also at the Wells Fargo Investment Institute. “We recommend a phased plan to deploy cash over the next year (or longer) and continue to focus on quality and defense in an effort to preserve capital.”
Short-term investors looking at a six- to 18-month horizon could benefit from holding additional cash and expect opportunities to enter the market in the coming months, Wren said.
Buy quality bonds and avoid junk – or high-yield – bonds, the strategists said.
“We prefer quality over junk food as markets dive deeper into the end of the cycle,” Morgan Stanley strategists said. “We’ve seen a sustained outperformance of quality versus junk since November 2021, when the shift to a more hawkish Fed happened.”
Moreover, the attractive income that bonds offer would offset the effects of widening spreads in a moderate recession, according to US asset manager Nuveen. A yield spread is the difference in yield between government and corporate bonds of the same duration. He recommends higher quality corporate bonds.