Recession fears and the stock market—is it too late to play defense?

Fear is understandable. While the job market remains strong, Inflation has reached its highest level in four decades He has consumers in landfills, According to sentiment readings.

The Fed is playing catch-up

Looking at the Federal Reserve Late scramble to tighten monetary policy At a rapid pace – including the potential for multiple huge increases of half a percentage point in interest rates. It is also considering reducing its balance sheet much faster than it did in 2017-2019.

Fed officials, of course, say they are confident they can tighten policy and lower inflation without crashing the economy, achieving what economists refer to as a “soft landing.” There are prominent skeptics, including former Treasury Secretary Larry Summers, whose early warnings of rising inflation proved prescient.

Key words: Larry Summers says recession now is the ‘most likely’ outcome for the US economy, not a soft landing

Eyes on the curve

Then there is the yield curve.

The two-year Treasury yield TMUBMUSD02Y,
2.497%
It was briefly trading above the 10-year Treasury yield TMUBMUSD10Y,
2.858%
advance this month. The prolonged inversion of this measure of the curve is seen as a reliable stagnation indicator, although other measures that have proven to be more reliable have not yet flirted with reversal.

Read: Leading yield curve researcher says US recession ‘not blinking red’ yet

The yield curve, even when the flash symbol is red, Not much of a stock timing indicator, analysts emphasized, noting that the period between the onset of the recession, as well as the peak of the market, could last for a year or more. However, her behavior is getting attention.

Meanwhile, stocks tumbled last week, cut short to four days by Good Friday, as the 10-year Treasury yield surged to its highest since December 2018, the brutal Russian invasion of Ukraine continued and major banks earned a earnings season. to a mixed start.

Need to know: Default risks, commodity shocks and other things investors need to remember as the Ukraine war enters a new phase

Dow Jones Industrial Average DJIA The S&P 500 fell 0.8%. SPX It fell 2.1% and the Nasdaq Composite Index COMPLargely weighted by interest rate-sensitive technology stocks and other growth stocks, it fell 2.6%.

take a defensive position

While only time will tell if a recession is imminent, the sectors of the stock market that do best when economic uncertainty is on the rise have already significantly outperformed the broader market.

“During periods of total uncertainty, some companies/industries outperform simply because they have less risky business than regular S&P,” Nicholas Colas, co-founder of DataTrek Research, said in an April 14 note. Big-cap US utilities, consumer staples, and health care — often described as primary defense sectors — all outperform the S&P 500 SPX,
-1.21%
This year and over the past 12 months.

The S&P 500 is down 7.8% year-to-date through Thursday, while the utilities sector is up 6.3%, basic commodities are up 2.5%, and healthcare is down 1.7%.

Colas has dived deeper to examine whether these segments are outperforming in this part of the market cycle. He studied 21 years of annual relative return data for each sector, a measure of how each group performed against the S&P 500 over the previous 253 trading days.

Results:

• Utilities saw an average annual relative performance against the Standard & Poor’s 500 from 2002 to the present of 2.8%. The outperformance was 9.9 percentage points over the past 12 months through Wednesday, just over a standard deviation from the long-term average.

• Staples has seen an average annual performance of -2.2% versus the S&P 500 over the past 21 years. The outperformance was 7.6 percentage points over the past 12 months, just under one standard deviation from the long-term average.

• Healthcare saw an average annual outperformance of 0.7% against the S&P 500 over the long-term, while the past 12 months of outperformance (10.7%) were more than one standard deviation from the long-term average.

room to run?

Colas said that such strong numbers can give the impression that these sectors can perform better than the performance of these sectors. But, in fact, they have fared stronger during past periods of overall 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 suggest you consider weighting up these defensive groups,” he wrote. “Yes, they all succeeded, but they are not yet outdated if the US/global macroeconomic background remains volatile.”

Coming attraction

The major banks on Wall Street presented a mixed set of results to kick-start earnings season, which is in full swing next week. Highlights will include Results from Tesla Inc. electric car industry
TSLA,
-3.66%
On Wednesday, with investors also concerned about whether CEO Elon Musk will face distractions as he follows up on Twitter Inc.’s presentation. TWTR,
-1.68%.

The Economic calendar It features a batch of housing data early next week, while the Federal Reserve’s Beige Book of Economic Conditions summary is due out Wednesday afternoon.