What do the current recession odds look like? While some argue that they’re falling, others see the risk rising despite promising data suggesting that the U.S. may finally begin to see inflation within the next few months. There are signs that the tide is turning and investors are turning less bearish, although in general, Wall Street is not bullish by a long shot.
Not everyone is convinced that we’re in recovery mode just yet though, and they’re still looking for help from the Federal Reserve, even though historical evidence suggests that policymakers have little influence on the economy despite their best efforts.
Equities, credit, commodities all rally
JPMorgan analyst Jan Loeys and team said this week that they think the recession odds are actually rising rather than falling, as others have suggested. They now peg U.S. recession odds at one-third within the next 12 months, which is worse than where they were placing the odds at previously.
However, equity-implied odds have moved in the opposite direction, falling almost to one-fifth as equities, credit and commodities have all rallied over the last three months, they said. Loeys and team suggests that the winding down of the troublesome fourth quarter earnings reporting period may have something to do with investors’ slightly cheerier outlook on the economy as some of the “immediate threats” are no longer receiving the amount of attention they were receiving.
But even if there is no earnings this year or next year, they don’t expect U.S. earnings to grow very quickly as they are projecting a low-single-digit increase. As a result, they don’t see anything that would cause them to raise multiples. Further, they said the “eventual” recession should send U.S. equities plunging by 30% or more, meaning that they see a “strong downward risk skew to returns over the next few years.”
Moving underweight on stocks, thanks to the rally
Because of the recent rally in stocks, the JPMorgan team has moved underweight on stocks compared to high-grade corporate bonds and cash. They do note though that momentum in equities remains strong for now, so their underweight position remains small at first. The one exception to their bearish view on stocks is high-dividend stocks, which they particularly like.
They add that low growth and “easy money,” plus lower possibility for capital gains, will likely up income demand, which they focus on high-grade corporate bonds because the yield is still over 4% as this doesn’t happen very often in this asset. At this time, they’re not moving toward foreign exchange or commodity carry. They’ve shifted to long duration on fixed income.
Portfolio adjusted for worsening recession odds
The JPMorgan team said their portfolio is now 5% underweight equities, which is the first underweight this cycle. They remain 10% overweight on credit and shifted bonds to neutral and cash to overweight. They remain underweight commodities, although they’ve raised it to -1% because of the market’s recent momentum and volatility.
Within equities, they recommend being overweight on defensive sectors. They’ve shifted to overweight on emerging market equities because they have shifted their “risk focus” from Chinese debt to caution on U.S. corporate debt. Within the credit market, they’re overweight U.S. high-grade corporate bonds, U.S. banks and sterling HG versus euro and emerging markets. They recommend a short position on gas, oil and base metals but an overweight on gold.