Inventory Market Outlook, Financial institution of America Playbook for Recession Investing

• Financial institution of America economists say a gentle recession is coming in 1H 2023.
• For buyers, this implies a tough panorama to navigate forward. 
• In a webinar on Monday, the financial institution’s inventory chief Savita Subramanian shared her playbook.

Economists at Financial institution of America see bother coming. 

Based on Michael Gapen, the financial institution’s head of US economics, a gentle recession will happen someday within the first half of subsequent yr as coverage tightening from the Federal Reserve will result in a slowdown in client spending. Shopper spending performs an important position within the US financial system, because it accounts for two-thirds of GDP.

The excessive danger of a downturn forward makes the present investing atmosphere a tough one. Savita Subramanian — the financial institution’s head of US fairness, quantitative, and ESG technique — mentioned in a Financial institution of America webinar on Monday that she sees the market having a rocky begin to subsequent yr earlier than going into “restoration mode” within the second half of 2023. 

That is not superb for buyers seeking to put their cash to work now (although Subramanian mentioned the S&P 500 is in a superb place to ship engaging long-term returns). However for the yr forward, she shared her five-part playbook for thriving throughout a downturn.

First, Subramanian mentioned she likes sectors of the market that provide free-cash-flow yields, rising earnings streams, and safety from inflation. Proper now, the vitality and financials sectors meet these necessities, she mentioned, although the usually cyclical sectors aren’t normally thought of recession-proof.

Although vitality has had an enormous run in 2022 — year-to-date, vitality sector funds are up virtually 60% — Subramanian thinks it has additional to climb as provide ranges will stay suppressed going ahead.

“I believe the bull-case for vitality is de facto the concept that as we transition from the place we’re at the moment to the kind of cleaner, greener world, the position of oil goes to be an necessary one,” she mentioned. “And the chance of provide coming on-line in an atmosphere the place corporations are being dissuaded from producing fossil fuels, and banks are being dissuaded from lending to corporations that produce fossil fuels, that supply-demand story is, to me, a very fascinating long-term bull-case for vitality.”

She added: “Finally we’ll get to net-zero, however I believe it’ll be loads longer than what’s priced into WTI and into the vitality shares at the moment.”

As for financials, Subramanian says the sector is well-positioned as a result of it is turn out to be larger high quality when it comes to corporations’ stability sheets, and is much less delicate to credit score situations than it was through the 2008 downturn. 

“I really suppose it may well climate a downturn higher than buyers anticipate, and even throughout COVID we noticed financials undergo a fairly restricted earnings recession relative to different cyclical sectors,” she mentioned. 

Subsequent, Subramanian likes two sectors which might be extra conventional recession performs: client staples and utilities.

“Relying on the size of the recession, to me, client staples and utilities appear to be excellent locations to park capital, clip a coupon from a dividend, and keep away from a few of the not simply financial danger, but in addition geopolitical danger, that we’re going through,” she mentioned. 

Longer-term, Subramanian mentioned the utilities sector may proceed to profit from excessive ranges of capital spending into inexperienced vitality. For client staples, she mentioned she would begin shifting out of the sector as soon as the financial system exhibits clear indicators of a restoration.

Publicity to the above areas of the market will be present in exchange-traded funds just like the Vanguard Financials ETF (VFH); the Power Choose Sector SPDR Fund (XLE); the Constancy MSCI Utilities Index ETF (FUTY); and the Shopper Staples Choose Sector SPDR Fund (XLP). 

Lastly, Subramanian listed areas of the market she thinks buyers ought to keep away from within the coming months, together with data know-how, communication providers, client discretionary, and supplies sectors. It’s because they’re cyclical sectors, which are inclined to undergo when the financial system slows.