Recession obsession: How to navigate a well-telegraphed downturn

It’s hard to miss the threats to the economy. In the US, we’ve seen banking turmoil while in Europe, markets are facing the challenges of persistent inflation coupled with a devastating crisis.

On a positive note, economic growth in the UAE remains a relative outlier, although we expect economic growth to slow throughout 2023 to over 2.6 per cent, down from 2022’s impressive over 7.9 per cent growth. While we don’t see an imminent recession in the UAE, we agree with the market consensus that the US will likely face a recession at some point over the next six-12 months. But we still believe that diversified portfolios can continue to generate strong returns heading into 2024.

While the recession obsession continues, we’re challenging clients to think about how to navigate this well-telegraphed downturn.

1. Rebuild your equity portfolio now for the next bull market

We believe the worst of the equity bear market is over. Recession or no recession, we don’t think the market will revisit the lows of October last year.

Here’s why: First, corporate profit growth, the driver of equities gains, is better than many realise. Profits and margins are slightly down from all-time highs, and no, demand isn’t booming. However, sales are resilient, transportation and energy prices are cheaper, the dollar is weaker, and the labour market is less competitive. Thus, analysts’ 12-month earnings expectations for the US, Europe, and China have started rising.

Globally, we believe that there are opportunities in themes like dividend growth, the energy transition, and the next wave of digital innovation.

Across sectors, we prefer healthcare and technology stocks – a number of leaders in these fields can be found in the Middle East.

2. Keep a global perspective despite recession worries

Over the last 10 years, the US stock market has outperformed Europe by 90–125 per cent depending on the reference currency, and China by a whopping 175 per cent. We see reason to believe the tide could be turning and that clients should consider a globally diversified portfolio.

We are bullish on European equities, with a particular focus on the so-called national champions. These multinational corporations, rooted in Europe, have a strong global presence and are distinguished by their earnings potential and commitment to delivering returns to shareholders.

In terms of China, we believe that valuations are reasonable and anticipate mid-teens earnings growth. Policymakers in China have also demonstrated a shift towards more market-friendly practices.

Notably, new credit growth, a key indicator of government support for the economy, is at its highest level since before the pandemic. Investing in China does come with higher risks compared to many developed markets. However, we believe that certain investors could potentially experience higher rewards for taking on that risk in the second half of the year.

3. You may hold too much cash and not enough bonds

Cash proved to be a good shelter in 2022 as interest rates rose and money fund and treasury bill yields increased. However, we believe the cycle is now complete, and over the next 12 months, the Federal Reserve may even consider lowering rates.

While cash outperformed other assets in 2022, it has underperformed global equities year-to-date and is in line with core bonds. We anticipate that cash will continue to underperform for the remainder of this year and beyond.

In the long term, we expect cash rates to align with inflation, which is likely to be around 2.5 per cent. Core investment grade bonds, on the other hand, have the potential to provide a return of over 4.5 per cent per year.

Turning to the short-term outlook, we believe cash rates have reached their peak. Investors may be better off locking in longer-term rates now rather than waiting for rates to decline in the coming quarters.

Looking at historical data, core fixed income has consistently outperformed cash in the two years following the final interest rate increase by an average of 14 per cent. Finally, bonds once again are providing a stable source of income and the potential for portfolio protection in an economic downturn.

Investing is about building portfolios that can power through risks over the long term. While it may be too soon to say this is a new bull market, we don’t think it’s a bear market either. Equities can grind higher, bonds can provide stable returns, alternatives can access idiosyncratic opportunity. All can potentially outperform cash over the long run, recession or no recession.

The writer is the head of Investments for the Middle East and North Africa at J.P. Morgan Private Bank