Russel Investments’ Strategists Expects a Delay in Recession
According to Russell Investments’ strategists, a recession for the slowing U.S. economy is expected, though they anticipate a delay until 2024 as investor enthusiasm for artificial intelligence and resilient economic growth continue to support stocks in the near term.
“Forward-looking recession indicators are all flashing warning signs, while measures of real economic activity such as jobs growth and household spending are only gradually moderating,” Andrew Pease, global head of investment strategy at Russell Investments, said. “This creeping slowdown in the United States seems likely to persist for a few more months.”
Pease believes a later recession could be milder since inflation should have fallen by enough at that point to allow the U.S. Federal Reserve to ease aggressively. A recession beginning in 2023 while inflation is still above the Fed’s target would limit the pace of easing.
Pease added that most other major economies are also slowing and at risk from aggressive central bank tightening. This includes eurozone growth buckling under a steep decline in bank lending, persistent inflation forcing the Bank of England to tighten further despite the lack of UK economic growth and China’s growth impulse faltering after the post-pandemic lockdown surge.
“While eurozone equities have performed broadly in line with U.S. equities so far this year, we expect they’ll soon face the cycle challenges of tight monetary policy and recession risks,” Pease said.
The firm’s strategists summarize their mid-year 2023 asset-class preferences as follows:
Equities have limited upside with recession risk on the horizon. Although non-U.S. developed equities are cheaper than U.S. equities, the team has a neutral preference until the Fed becomes less hawkish and the U.S. dollar weakens significantly.
The team views the U.S. equity market cautiously due to expensive valuations and a deteriorating business cycle. In addition, their proprietary index indicates investor sentiment is now slightly overbought after being oversold at the beginning of the year. “Markets could melt upward over the next few months if investors begin to speculate (wrongly, in our view) that the resilience in the economic data suggests that a recession might be avoided,” Pease said.
Within equities, the team prefers the quality factor, which tracks stocks that have low debt and stable earnings growth. “Quality stocks typically show good relative performance during periods of economic slowdown, and they are relatively cheap at mid-year compared to the rest of the market,” Pease said.
Emerging markets(EM) have underperformed developed markets so far this year, despite the weaker U.S. dollar, which usually is a trigger for EM to outperform. “Concerns about China’s economy have been a headwind, and these worries seem unlikely to lift over the near-term. For now, a neutral stance is warranted,” Pease said.
High yield spreads are below their long-term average and investment grade credit spreads are close to their long-term averages. The poor cycle outlook is a challenge with default rates rising as U.S. recession probabilities increase.
Government bond valuations look increasingly attractive. U.S., UK and German bonds offer reasonable value. Japanese bonds, however, remain expensive. It is likely that the U.S. yield curve will steepen in coming months. The spread between 2-year and 10-year bond yields is close to an extreme. “The yield curve tends to steepen after the Fed has completed raising interest rates and markets start looking toward monetary easing,” Pease said.
Real assets: Valuations for REITs (real-estate investment trusts) continue to look attractive on a comparative basis. REITs should perform well when interest rates fall, given that real estate fundamentals appear reasonably healthy. Commodities face headwinds from the lackluster Chinese economy, particularly the poor outlook for infrastructure and construction activity. Oil prices have failed to rise following successive announcements of supply cuts by petroleum-exporting countries, and prices are unlikely to recover as global growth continues to slow. The supports for gold prices are unwinding as inflation declines and real interest rates increase.
The U.S. dollar has trended lower over the past month as investors speculate the Fed is nearing the end of rate hikes. It could weaken further if markets become confident that a recession can be avoided, given the counter-cyclical nature of the dollar. The Japanese yen is attractive from a cycle, value, and sentiment perspective.