(Bloomberg) — Even after one of the worst early stock trading years in history, the market turmoil may only be just beginning.
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Ominous signs that more shocks are coming are piling up as key indicators point to a potential recession. This could exacerbate the market downturn fueled by the Fed’s hawkish shift among central banks and the war in Ukraine.
The US Treasury yield curve has collapsed almost to the point of inversion, a situation where short-term rates exceed those with longer maturities, which often preceded a downturn. In Europe, the cost of energy has reached unprecedented levels as sanctions against Russia exacerbate global commodity shortages.
“Over time, the three biggest factors that tend to push the US economy into recession are an inverted yield curve, some sort of commodity price shock, or a Fed tightening,” said Ed Clissold, chief US strategist at Ned Davis Research. “Right now, there seems to be a possibility that all three events will happen at the same time.”
Food prices have already exceeded levels that fueled past uprisings and unleashed war between Russia and Ukraine, which together account for 28% of global wheat exports and 16% of corn, according to UBS Global Wealth Management. only increases the risk.
Meanwhile, the Fed is unlikely to intervene to prevent sell-offs, according to George Saravelos, global head of foreign exchange research at Deutsche Bank. This is because the root cause of the current surge in inflation is a supply shock, rendering the strategy that has been used to fight the recession for the past 30 years almost useless.
The chance of a recession in the US next year could be as high as 35%, according to economists at Goldman Sachs Group Inc., who lowered the bank’s growth forecasts due to soaring oil prices and the aftermath of the war in Ukraine. Bank of America Corp. said that the risk of an economic downturn is still low, but it will increase next year.
The story goes on
With a sharp and widespread economic downturn looming on the horizon, here is a guide on how to prepare based on the conversations and notes of fund managers and strategists.
Exodus from Europe
Although the year began with bullish bets on European equities, it is now ancient history. Record inflation, an unexpected hawkish reversal by the European Central Bank, and Vladimir Putin’s assault on Ukraine have changed everything, and a massive exodus from regional reserves is in full swing.
Strategists across asset classes see the Old Continent as the most exposed to war-related risks, not least because of its geographic proximity and energy dependence on Russia.
“There is a high chance of a recession for the eurozone if the situation does not quickly return to normal,” said Christophe Barrot, chief economist at Market Securities LLP in Paris. The risks include a confidence shock due to the war, a hit to household consumption due to higher food and energy prices, and heightened disruptions to the supply chain caused by the conflict, he said.
Even enthusiastic bulls like UBS Global Wealth Management downgraded eurozone stocks. Amundi SA, Europe’s largest asset manager, said on Friday that a temporary economic and income recession on the continent is currently possible.
On the positive side, much of the bad news for Europe may now have been explained, opening up pockets of opportunity. Strategists at Bank of America Corp. lifted the region’s cyclical stocks compared to defensive stocks, as well as stocks of automakers.
“The recent backlog makes them more realistic in price,” they said.
commodity harbors
Mining and energy are the only sectors that have weathered the decline in European stocks so far, and this is likely to continue unless higher prices wipe out demand in the process.
“The energy sector in equities is one area that provides a hiding place,” Nannet Hechler-Fayd’Herbe, global head of economics and research at Credit Suisse Group AG, told Bloomberg TV. “At best, growth is accelerating and the energy is sustained by that. In the worst case, prices continue to rise, and the energy sector continues to be supported.”
In the emerging landscape, the UK has been touted as a potential haven due to the abundance of inventory in the FTSE 100 index. While MSCI’s global equity benchmark has fallen 11% this year, the UK Large Cap Index has shed just 3%.
Energy and commodities companies, along with the traditionally defensive health and utilities sectors, together make up 58% of the FTSE 100 — index members such as Shell Plc and Glencore Plc surged on fears of supply cuts. This figure drops to around 31% for the MSCI world benchmark.
Opaque industries such as agricultural chemicals are also doing well, and continued tensions in fertilizer markets due to the war in Ukraine may bode well for companies such as Yara International ASA, OCI NV, Mosaic Co. and Nutrien Ltd.
US staples and retail have also historically outperformed during periods of stagflation, UBS strategists Nicolas Le Roux and Bhanu Baweja wrote in a note.
booze and chocolate
Of course, not all yield curve inversions, tightening cycles, and commodity price spikes lead to economic downturns. But there are risks, and investors looking for shelter must act, even though it may be too late.
The US market expects a recession to start an average of seven months and bottom an average of five months before the end of the recession, according to CFRA data dating back to World War II.
By the time the National Bureau of Economic Research tells us we’re in a recession, “it’s time to buy,” said Sam Stovall, CFRA’s chief investment strategist.
And if you don’t know what to buy amid market uncertainty, Dimitris Valatas of Greenmantle has a home to recommend.
“The historical evidence for the last global inflationary period of the 1970s is clear,” he said. “In real terms, in large countries, housing outperforms every other major asset class, including stocks.”
But to gain a foothold in the stock markets, it’s worth keeping an eye out for the purveyors of life’s amenities that people can’t do without, must-have technologies like Microsoft Corp.
When a crisis strikes, “consumers are usually looking for small pleasures,” said Edmund Sching, chief investment officer at BNP Paribas Wealth Management. “Buying new cars or smartphones suffers, while booze and chocolate tend to do the trick.”
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