3 Midyear Portfolio Strategies for Waiting on a Recession

“The range of potential market outcomes has never been wider,” State Street's strategy team writes.

Investors “on edge” and looking to protect unexpected gains from this year’s strong first half may need to wait longer to gain clarity on when a recession will arrive and how severe it may be, according to analysts at State Street Global Advisors’ SPDR business.

In the meantime, they might consider three strategies for building investment portfolios for the year’s second half, the firm said in a recent midyear ETF outlook.

Investors “are anxiously awaiting the titular recession that may or may not arrive this year. Most economists expect a recession in the next 12–18 months,” Michael Arone, chief investment strategist for State Street’s U.S. SPDR business, and other researchers noted.

“But until the resilient consumer and strong labor market falter, investors will likely have to wait a while longer for the anticipated recession — which might take a few more quarters to unfold,” they wrote.

There’s never been a market bottom before a recession began, “further fueling investors’ anxiety,” the State Street team said, citing Strategas Research Partners data. And investors may have good reason to doubt the rally’s durability, given that just half the S&P 500 stocks recently were trading above their 200-day moving averages, they wrote.

More stocks may participate in this year’s rally once investors gain clarity on a recession’s timing and severity.

Clarity on macroeconomic issues, including recession and the direction of future monetary policy, “hopefully will result in more stocks participating in this year’s rally — finally enabling markets to break through the ceiling,” State Street’s team wrote.

“While we wait, the range of potential market outcomes has never been wider. That makes diversification — a strategy that helps portfolio performance when the unexpected happens, like in the first four months of 2023 — more important than ever.”

They suggested investors consider three portfolio strategies for the second half.

Move up in quality in the U.S. and rotate overseas.

Even with gains in the first half, U.S. stocks continue to be vulnerable to earnings risk, leaving the risk/reward equation skewed to the downside, according to State Street.

Investors should consider “more repeatable cash flows and durable balance sheets, trading at inexpensive valuations,” according to State Street. “This includes firms known to increase their dividends.”

Investors should also consider stocks in developed markets outside the U.S. given the “improving outlook overseas,” the team writes.

Seek income and balance risks with bond ETFs.

Risks and credit fundamentals in the bond market are unbalanced now, State Street’s team noted.

Despite the risks, “bonds are inherently more attractive than stocks right now,” they said. “That’s because stretched stock valuations and elevated bond yields have tightened the equity risk premium below its historical median.”

Investors can get the most value from bonds by balancing risks, according to the firm, which suggested they consider:

Diversify recession risks with cyclicals and defensives.

Investors should consider blending cyclical and noncyclical exposures, State Street suggested.

Market optimists might believe the economy will enter no more than a protracted slowdown, while pessimists are more likely to brace for recession, the team noted, adding that these divergent views “make portfolio diversification even more vital now.”

To pursue current cyclical opportunities while keeping protection from a potential downturn, State Street says, investors should consider mixing these approaches in some way:

State Street recommended various SPDR ETFs to achieve these portfolio-building goals.

(Image: Bloomberg)

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