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Schwab Sector Views: Sector Moves for Recession Fears

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

March 05, 2019

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2 years 4 months
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Schwab Sector Views

Recession fears appear to be rising in the U.S., with economic data showing signs of slowing growth and earnings gains declining.

We’re not in the impending-recession camp, but do believe that risks have risen and the possibility isn’t off the table.

The kneejerk response may be to sell equity positions and let the potential storm pass, but we believe there is more prudent action to take that may still help allay some fears. 

Schwab Sector Views is our three- to six-month outlook for 11 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks. 

Listen to the latest audio Schwab Sector Views.

Recession fears rising

It has been a while since the last U.S. recession hit in 2008, but it seems that the memories of that period have been slow to fade, likely due to the severity of the downturn. And with the length of time since the last one, and the developments in the U.S. economy, it seems that fears of another recession are rising. Part of the reason I am addressing this topic now is that I’ve gotten numerous client questions surrounding the possibility of the recession in the last few weeks. Also, The Washington Post recently reported that Google searches containing the word “recession” are at the highest level since 2009, toward the end of the last recession. With concerns rising, investors are wondering what to do, and a kneejerk response may be to sell equities and move into cash. But we suggest that may not be the best strategy. First, we aren’t guaranteed to have a recession in the near future. In fact, we’re in that camp although the risks have risen. Second, it’s not just the sell you have to get right, it’s also the buying back in—a tough double in our view. 

But that doesn’t mean there’s nothing you can do!

Business cycles and sectors

Taking a little step back, let’s take a quick look at the relationship that the business cycle has with sectors. In our view, contrary to some opinions out there, the process of an economic business cycle has not ended. There are still phases—early expansion, maturing expansion, late expansion, and recession—that the economy goes through. While past performance is no guarantee of future results,  throughout the history of the stock market we’ve noticed certain sectors tend to do better during different stages of the cycle. For example, from our observations the consumer discretionary sector has tended to be a pretty consistent early-expansion outperformer, while sectors such as health care, consumer staples and utilities have seemed to perform better during late-expansion into recession periods. The nice thing about the business cycle and sectors is that they typically make intuitive sense. As the economy starts to dig out of a recession, the forward-looking stock market surmises that consumer spending is going to start to increase, potentially benefiting the discretionary sector. Likewise, when investors start sniffing out a recession, sectors who deal with products and services that are unlikely to fluctuate greatly become more attractive. 

So where do we stand? 

Of course, the challenge is often determining where we are in the business cycle at any given time. To us, it appears that we are somewhere in the late-expansion period, although that can last a while and a recession may not be in the immediate future. Also, it’s important to remember that every business cycle is different, which can affect the performance of sectors more than just the general business cycle—for example, the financial sector’s terrible performance during the last downturn, which was centered on the housing market. So while we don’t think we’re in for a near-term recession—largely due to the Federal Reserve’s move to pause its rate-hike campaign—it does seem like economic growth is slowing. There are multiple data points we could point to, but I don’t want to bore you, so we’ll just look at a couple of broader indicators: the Citigroup Economic Surprise Index has declined sharply, while the New York Federal Reserve’s measure of recession risk by factors in the yield curve has risen lately. 

Economic surprises declining

Citigroup Economic Surprise Index - US

While recession odds appear to be rising

NY Fed Recession Probability

Additionally, despite the healthy job market—unemployment is near a historically low level, according to the Labor Department—we are seeing signs of stress, with auto loan delinquencies rising to their highest level since the last recession. 

And there are signs of consumer stress

90-day delinquencies, auto, percent

And what can you do?

If these and other data have you concerned about your portfolio, we suggest it may be prudent to make some tactical tweaks to your equity holdings rather than abandoning ship. We already have an outperform rating on the health care sector, and we outlined reasons why in the last issue, so I won’t spend time on that here. But yields in the utilities and consumer staples sectors could provide some measure of stability if there is a further downturn. We aren’t overly positive on these groups, as they both have headwinds that could hold them back if we don’t get a recession. However, macroeconomic concerns have risen to the point where we rate them both at marketperform, meaning investors should have exposure to both of these often-ignored groups. And those investors who are more concerned about recession should consider having a little larger exposure. As mentioned, as economic growth slows, demand for heat, lights, toilet paper and detergent is unlikely to decline to any great degree. 

If the December Fed rate hike was indeed the last hike of this cycle, then health care, staples and utilities could be attractive places to be. According to Cornerstone Macro, in the 12 months following the last rate hike in cycle going back to 1974, those three sectors have tended to lead the way, with an average return of more than 20% for each of those groups during those periods. 

One note of caution, as mentioned, not every business cycle is the same and these are still equity sectors that have risks associated with them. Just recently we’ve seen examples of that as Kraft Heinz stock, in the staples sector, was punished following a $15.4 billion asset writedown (The Wall Street Journal), while in the utilities sector, Pacific Gas and Electric has struggled as it has been blamed for contributing to the starting of devastating forest fires in California (The Wall Street Journal).

So what?

There are always risks with equity investing, but there are also risks associated with sitting out of the market, with the loss of potential earnings and purchasing power as inflation eats away at the value of cash. So while certainly not a guarantee, we suggest that investors who are growing more concerned about a potential recession consider not reducing their overall equity position, but rather shift it around a bit by looking to add to the consumer staples and utilities sectors. 

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date total return as of 3/12/19

Communications Underperform 09/28/2018 10% 14.75%

Consumer discretionary

Marketperform

07/17/2014

10%

11.33%

Consumer staples

Marketperform

05/07/2015

7%

8.13%

Energy

Marketperform

11/20/2014

6%

14.10%

Financials

Marketperform

08/16/2018

13%

10.40%

Health care

Outperform

01/26/2017

15%

5.36%

Industrials

Marketperform

01/29/2015

10%

15.29%

Information technology

Marketperform

08/16/2018

20%

15.74%

Materials

Marketperform

01/31/2013

3%

10.25%

Real estate

Marketperform

08/16/2018

3%

14.70%

Utilities

Marketperform

08/16/2018

3%

10.29%

S&P 500®  Index (Large Cap)

 

 

 

11.82%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 2/28/19.

 

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 11 stock market sectors, which are based on the 11 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: Likely to perform better than the rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor’s 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views’ outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it’s time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks.

To discuss how this article might affect your investment decisions:

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