Trading Strategies for Investors Concerned About Rising Recession Risks

Countries like the US and UK are grappling with inflation that has surged to multi-year highs as the war in Ukraine has caused energy prices to skyrocket and food prices to rise.

Angela Weiss | AFP | fake images

There is increasing talk of a recession, with Wall Street veterans pointing to the growing risks of a recession 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 bear case because the risk of one “has increased considerably.”

“It goes without saying that there are numerous shocks to the economy right now that could send us into a recession at some point in the next 12 months,” the investment bank said in a May report. He cited factors such as an escalation of the Russian-Ukrainian war that may push oil prices to $150, the extremely strong dollar, and crushing cost pressures on businesses.

Wall Street veteran Ed Yardeni, who had said in April there was a 30% chance of a recession, last week raised that figure to 40%, while Citi CEO Jane Fraser told CNBC she was convinced that Europe is heading towards a recession.

The war in Ukraine has caused energy prices to skyrocket 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 posted steep declines since peaking in late 2021 and early this year, with the Nasdaq losing about 23% since the start of 2022. The S&P 500 is down about 13% in the same period.

Here’s how restless investors can ride out persistent turmoil in the stock market, experts say.

1. Buy these three sectors

With volatility set to remain, 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 come from the defensive end of the spectrum,” Morgan Stanley wrote. “We don’t think defensive stocks are going to have a huge outright run, but they should offer some relative protection as our call for lower earnings and multiples would hit cyclicals harder.”

Defensive stocks provide stable dividends and earnings regardless of the general state of the stock market, while cyclical stocks are stocks that can be affected by the economic cycle.

This is what Morgan Stanley has to say about the three defensive sectors:

  • Health care: The sector is trading at a discount to the broader market, unlike most other defensive sectors, according to Morgan Stanley. The bank prefers large-cap pharmaceutical and biotech stocks, adding that they are attractively priced and offer relatively attractive dividend yields.
  • Real estate: The sector gained 42% last year and has outperformed the broader US market by 16%, Morgan Stanley said. The bank likes this sector for its earnings stability and dividend income.

    “Stable cash flows within REITs should provide defensive exposure to market downturns in the coming year,” Morgan Stanley said.

    “In addition, REITs offer built-in inflation protection through leases, rent increases and property appreciation that should allow the sector to weather the high-inflation environment relatively better than other sectors,” he added.

  • Utilities: Valuations are already high, but Morgan Stanley is bullish on this sector more for its downside protection than any other bullish side.

    “With nearly every industry grappling with the effects of rising energy costs, the pricing structure in place within utilities should provide relative protection in this high-cost environment,” he said.

2. Be patient

A recession “requires extra patience” when laying down cash for any investment opportunity, the 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 reinvestments because bear markets can last around a year and sometimes lead to drawdowns of around 30%. .

“Long-term investors generally diversify at times like these,” added Scott Wren, senior global market strategist, also at the Wells Fargo Investment Institute. “We recommend an incremental plan to deploy cash over the next year (or longer) and continue to emphasize quality and defense in an effort to preserve capital.”

Short-term investors looking at a six- to 18-month horizon may benefit from having extra cash and waiting for opportunities to enter the market in the coming months, Wren said.

3. Buy investment-grade bonds

Buy quality bonds and stay away from junk, or high yield, bonds, the strategists said.

“We have a preference for quality over scrap as markets dive deeper into the late cycle,” Morgan Stanley strategists said. “We have seen a sustained outperformance of quality versus scrap since November 2021, when the move to a more aggressive Fed took place.”

In addition, the attractive income offered by the bonds would offset the effects of widening spreads in a mild recession, according to US asset manager Nuveen. A yield spread is the difference in yields between government bonds and corporate bonds of the same holding. Recommends investment grade corporate bonds.

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