As one contagion ends, another begins. The symptoms of a stagflationary slowdown are pronounced. About two-thirds of economists polled by the Financial Times expect a US recession. UK gross domestic product fell unexpectedly in April. Cryptocurrencies, a prime indicator of speculative exuberance, are slumping.
As equities and bonds lurch downward, investors are rushing for safety. The MSCI All-Country index (ACWI) has already lost 18 per cent in dollar terms this year. Lex is holding to its expectation of a long, grinding market correction amid extempore monetary policymaking. Here are some defensive strategies for the months ahead.
Bonds deserve attention, especially those denominated in the strong US dollar. Any bet on fixed income is dependent on where you think inflation will peak. In corporate credit, favour businesses with strong balance sheets and cash flows. A zero weighting to high-yield bonds makes sense.
As for stocks, defensive choices depend on how protected companies are from inflation, higher rates and slower growth, as Rob Buckland of Citi points out.
In the 1970s, energy and mining shares outpaced inflation. The same bet has worked this year. Two of the top three sectors within the MSCI ACWI include those groups. Currently, the value of all commodity consumption as a proportion of global GDP — nearly 11 per cent — approaches that of the second Opec oil shock in 1979.
Rising rates require the typical investor to tilt away from expensive growth. These are companies whose valuations depend on low, long-term discount rates, in sectors such as tech and renewables. Instead, buy defensive stocks with less “earnings beta” or sensitivity to broader profits volatility. Aim for telecoms and other utilities, consumer staples and healthcare shares.
Momentum-following algos tend to perform well in extended market corrections. Shares in Man Group, whose AHL product group meets that description, are up 11 per cent over six months.
Pundits do not unanimously predict a recession. Full employment and high bank capital ratios make RBC Wealth strategists optimistic about financials this year. But even they accept risks are mounting. They tip the UK stock market for its relative cheapness.
At 17.25 times, the forward earnings multiple for the S&P 500 index is just above its 10-year average. Shiller’s cyclically adjusted price/earnings ratio, which aims to smooth out economic peaks and troughs, remains relatively high. There is plenty of room for markets to fall further, so be prepared.
The Lex team is interested in hearing more from readers. Is a recession a certainty or is a contrarian tactic worthwhile? Please tell us what you think in the comments section below.
