A recession may be coming, but it doesn’t mean your portfolio has to suffer. We take a look at the latest events for cues on how to position
Our Top Market Takeaways for June 09, 2023
Market spotlight
5 ideas to drive your portfolio through recession obsession
Our 2023 Mid-Year Outlook: The Recession Obsession is hot off the press.
Obsession around a potential recession has been real, and there’s no doubt that headlines will continue to swirl into year-end—whether about central bank dynamics, inflation, fallout in labor markets, or [insert worry here]. But, despite all the angst, we see promise for investors. Our Outlook centers on five key ideas to navigate what feels like one of the most well-telegraphed recessions ever.
In today’s note, we pull out some highlights.
Key Idea 1: Rebuild your equity portfolio now for the next bull market.
It might not be all smooth sailing (we expect volatility ahead), but we think the worst is over for stocks. The S&P 500 is now 20% higher from its October lows, almost eight months ago! When stocks have rebounded that much from their nadir in the past, it has boded well for future returns. In the last 11 bear markets, after stocks rallied back 20%, the S&P was up on average another +22% over the next year.
History suggests the rally can keep going from here
The table describes the U.S. bear markets (S&P 500 Index) in history. And all bear markets are displayed in a list format. It’s shown from left to right in “#, Type, Description, Start (prior high), End (trough), Drawdown, Date of +20% rally from trough, 12-month return after +20% rally, recession?” • For the first bear market, the “#” is 1, the “Type” is Event-driven, the “Description” is Suez Canal Crisis, the “Start” is Aug ’56, the “End” is Oct ’57, the “Drawdown” is -22%, the “Date of +20% rally from trough” is July 25, ’58, the “12-month return after +20% rally” is 27%, the “recession?” is “x”. • For the second bear market, the “#” is 2, the “Type” is Event-driven, the “Description” is Flash Crash of 1962, the “Start” is Dec ’61, the “End” is Jun ’62, the “Drawdown” is -28%, the “Date of +20% rally from trough” is Dec 5, ’62, the “12-month return after +20% rally” is 18%, the “recession?” is “”. • For the third bear market, the “#” is 3, the “Type” is Event-driven, the “Description” is 1966 Financial Crisis, the “Start” is Feb ’66, the “End” is Oct ’66, the “Drawdown” is -22%, the “Date of +20% rally from trough” is Feb 14, ’67, the “12-month return after +20% rally” is 2%, the “recession?” is “”. • For the fourth bear market, the “#” is 4, the “Type” is Cyclical, the “Description” is Tech Crash of 1970, the “Start” is Nov ’68, the “End” is May ’70, the “Drawdown” is -36%, the “Date of +20% rally from trough” is Sep 24, ’70, the “12-month return after +20% rally” is 17%, the “recession?” is “x”. • For the fifth bear market, the “#” is 5, the “Type” is Structural, the “Description” is Stagflation—OPEC Oil Embargo, the “Start” is Jan ’73, the “End” is Oct ’74, the “Drawdown” is -48%, the “Date of +20% rally from trough” is Nov 5, ’74, the “12-month return after +20% rally” is 19%, the “recession?” is “x”. • For the sixth bear market, the “#” is 6, the “Type” is Cyclical, the “Description” is Volcker Tightening, the “Start” is Nov ’80, the “End” is Aug ’82, the “Drawdown” is -27%, the “Date of +20% rally from trough” is Sep 14, ’82, the “12-month return after +20% rally” is 34%, the “recession?” is “x”. • For the seventh bear market, the “#” is 7, the “Type” is Event-driven, the “Description” is 1987 Crash, the “Start” is Aug ’87, the “End” is Dec ’87, the “Drawdown” is -34%, the “Date of +20% rally from trough” is Mar 8, ’88, the “12-month return after +20% rally” is 9%, the “recession?” is “”. • For the eighth bear market, the “#” is 8, the “Type” is Cyclical, the “Description” is Early 1990s Recession, the “Start” is Jul ’90, the “End” is Oct ’90, the “Drawdown” is -20%, the “Date of +20% rally from trough” is Feb 6, ’91, the “12-month return after +20% rally” is 16%, the “recession?” is “x”. • For the ninth bear market, the “#” is 9, the “Type” is Structural, the “Description” is Tech Bubble, the “Start” is Mar ’00, the “End” is Oct ’02, the “Drawdown” is -49%, the “Date of +20% rally from trough” is Nov 21, ’02, the “12-month return after +20% rally” is 11%, the “recession?” is “x”. • For the tenth bear market, the “#” is 10, the “Type” is Structural, the “Description” is Global Financial Crisis, the “Start” is Oct ’07, the “End” is Mar ’09, the “Drawdown” is -57%, the “Date of +20% rally from trough” is Jan 19, ’09, the “12-month return after +20% rally” is 35%, the “recession?” is “x”. • For the eleventh bear market, the “#” is 11, the “Type” is Event-driven, the “Description” is COVID-19, the “Start” is Feb ’20, the “End” is Mar ’20, the “Drawdown” is -34%, the “Date of +20% rally from trough” is Apr 8, ’20, the “12-month return after +20% rally” is 49%, the “recession?” is “x”. • For the twelfth bear market, the “#” is 12, the “Type” is Cyclical, the “Description” is Central Bank Tightening, the “Start” is Jan ’22, the “End” is Oct ’22, the “Drawdown” is -24%, the “Date of +20% rally from trough” is Jun 8, ’23, the “12-month return after +20% rally” is ?, the “recession?” is “?”. At the bottom of the table, it provides the average number for 12-month return after +20% rally across the first 11 bear markets, which is 22%
But while stocks are up and the slide in earnings has been far better-than-feared, many investors have been reticent to jump back in. Our clients have been net buyers of equities in just 7 of the 30 weeks since the market bottomed in October. That’s left the majority with a lower allocation to equities today than they did a year ago.
Yet, stocks are the engines of capital appreciation in portfolios, and our Long-Term Capital Market Assumptions estimate equities will average returns of 7.5 – 10% per year over the next 10-15 years (depending on the region), handily outpacing expected annual U.S. inflation of 2.6%. When investors are fearful and markets dip, that’s often the time to pounce and use volatility to rebuild positions.
Key Idea 2: You probably stay too close to home with your investments.
Half of our U.S. clients are materially underweight Europe, and two-thirds have little to no exposure to China. That may have been a good bet in years’ past, but such positioning could leave investors wrong-footed as the tide turns.
Europe defied expectations for a recession last winter, and stocks rallied in thanks. Still, Europe trades at a significant discount to the U.S. Even if you strip out U.S. mega cap tech, European stocks are at a 16% discount to the U.S.—wider than the 10-year average of -8%. On top of valuation tailwinds, add continued economic and earnings resilience and a weaker dollar, and we still think the Europe rally has legs—even if that pace of outperformance tempers.
Europe is trading at a wider than usual discount to the U.S.
On the other hand, geopolitics and a mixed reopening recovery have made China a tough call. But, that also means valuations are even more reasonable today. Economic policy is supportive (net new credit growth is once more on the rise), and a steady release of pent-up consumer savings should help support a durable recovery (despite it likely moderating from here). We think all of that could propel markets in the second half of the year.
Key Idea 3: Manage your concentrated positions.
The market swings of the last few years serve as a warning against putting all your eggs in one basket. While the broader Russell 3000 is just -12% off its 2021 highs as of yesterday’s close, one out of every four stocks in the index is down more than 75%. So while concentrated stock positions can create substantial wealth, they also come with a high probability of dramatic losses that can potentially derail the financial future you had envisioned for you and your family—especially during times of volatility.
Roughly 1 out of 4 stocks in the Russell 3000 have fallen over 75% from 2021 highs
The chart describes the index drawdown of Russell 3000 and the 1 out of every 4 stocks drawdown of Russell 3000 from the 2021 high. The column on the left describes the % index drawdown of Russell 3000 from the 2021 high. The column shows that the drawdown is -12%. The column on the right describes the 1 out of every 4 stocks % drawdown from the 2021 high. The column shows that the drawdown is -75%.
Hindsight is 20/20. History suggests the risks of investing in a “losing” company are high, with most causes of catastrophic losses only obvious after the fact or outside of management’s control: government policy changes, regulation, commodity price risks, foreign competition, technological innovation, fraud or changes in consumer behavior. We’ve seen this play out again and again over history. The good news is that there are a number of ways you can manage the risk.
Key Idea 4: You may hold too much cash and not enough bonds.
Disinflationary forces are brewing. Used car prices, one of the OG villains in the inflation epic, can now be used as an example of forces pulling inflation lower. The Manheim Used Vehicle Index fell -2.7% last month, following a -3.1% decline in April. On a year-over-year basis, prices are down -7.6%.
Companies are also noting the shift, like Campbell’s Soup this week remarking that consumers aren’t buying as much soup at these higher prices. Meanwhile, most commodity prices have deflated well off their cycle highs, whether we’re talking about coffee (-20%), European natural gas (-90%), steel (-52%), or cotton (-47%).
Obviously, central banks don’t think that our inflation problem is over yet, but seeing prices cool across both discretionary and non-discretionary items is encouraging. We don’t think it will take many more hikes for the Fed to finish its part (perhaps just one more this summer), which means risk-free yields are likely at or near their peak for this cycle.
Given that ~25% of our clients’ investable assets are being held in cash or cash-like instruments right now, reinvestment risk should be top of mind. Now is the time to extend duration and lock in elevated yields for longer.
Key Idea 5: Know the risks—and opportunities—in regional U.S. banks and real estate.
While the most acute banking stress seems to have subsided, the flow of credit is slowly drying up—46% of U.S. banks are now tightening lending standards, reticent to take more risk on their books.
But, companies still need access to credit, prompting many to turn to private lenders for their borrowing needs. That means private credit markets are able to fill a void, and earn a good premium: With rates higher and credit spreads wider, new loans in the private credit market are originating at much wider spreads—around 300bps wider than public market pricing.
What’s more, as default rates start to rise, opportunistic and distressed credit managers can sift through the damage and pick up quality assets at a discount.
That’s all to say, there may yet be ripple effects, but risks around banks and real estate can also bring opportunities—if you know where to look.
BONUS: Follow the dollars.
Presidential campaign announcements are popping up left and right, and eventually they’ll bring policy proposals with ambitious goals for the future. Instead of taking the debate bait about which ones could work, steer toward what’s already been passed: The 2021 Infrastructure Investment and Jobs Act (IIJA), the 2022 Inflation Reduction Act (IRA) and the 2022 CHIPS and Science Act (CHIPS) represent an estimated combined $2.4 trillion in public and private spending over the next 10 years.
Together, the three bills compose the largest commitment to industrial policy in the United States since the Cold War—with cascading macroeconomic effects. That also supports our view that in the new emerging market cycle, “real economy” stocks should outperform the growth stocks that dominated the 2010s.
Three recent federal acts begin with the most ambitious industrial policy project since the Cold War era
The chart describes total spending resulting from federal policy initiatives as % of GDP. The bar on the left describes the total spending from the Manhattan Project, which was at 0.4% of GDP. The bar in the middle describes the total spending from the Federal-Aid Highway Act, which was at 1.8% of GDP. The bar on the right describes the total spending from the Industrial Policy Bills of 2012-2022, which was 0.7% of GDP in total. It was also divided in private spending (0.4% GDP) and public spending (0.3% GDP).
For more, dig into our 2023 Mid-Year Outlook: The Recession Obsession.
All market and economic data as of June 2023 and sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.
We believe the information contained in this material to be reliable but do not warrant its accuracy or completeness. Opinions, estimates, and investment strategies and views expressed in this document constitute our judgment based on current market conditions and are subject to change without notice.
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• Past performance is not indicative of future results. You may not invest directly in an index.
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