SUPERNEWS

Macro

Rally Hides Recession Signs, Time for Defensive Stocks?

Market rally contrasts with weakening economic indicators, suggesting investors pivot towards defensive strategies amidst recession signals.

By Athena Xu

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5/9, 19:03 EDT
S&P 500
iShares 20+ Year Treasury Bond ETF
iShares 7-10 Year Treasury Bond ETF
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Key Takeaway

  • Despite strong earnings and near-record equity highs, economic indicators like ISM Manufacturing and Services signal a potential recession.
  • Consumer spending power is waning with the depletion of pandemic savings, suggesting a shift towards defensive stock investments may be prudent.
  • Credit markets show signs of strain despite current optimism, indicating investors should prepare for possible downturns.

Recession Signals Intensify Amid Market Rally

Despite a robust market rally, underpinned by strong earnings growth and equities nearing record highs, the US economy is showing signs of softening that investors cannot afford to ignore. The Bloomberg US economic surprise index has plummeted to its lowest since late 2022, indicating a slowdown in growth. This downturn is underscored by the contraction in both the ISM Manufacturing and ISM Services indices, historically reliable indicators of economic downturns. Furthermore, consumer spending power is waning, with pandemic excess savings depleted and a rise in "Buy Now, Pay Later" services contributing to growing concerns over "phantom debt."

Labor Market and Credit Conditions Worsen

The labor market is showing cracks, with a potential rise in the unemployment rate to 4.0% in the coming months, which could signal a recession according to the Sahm Rule. In the credit markets, despite a surge in issuance, the extra yield on US corporate debt is compressing, suggesting an approaching nadir in fundamentals. This scenario is juxtaposed against a backdrop of investors still buoyed by corporate America's strong earnings performance and optimistic GDP growth forecasts.

Shift Towards Defensive Investing

As economic indicators worsen, a strategic shift in stock investment towards cheap defensive shares and large caps over small caps is anticipated. The tech sector, despite its current crowded state, remains buffered by earnings growth but is vulnerable to rapid unwinding. On the credit side, deteriorating fundamentals hint at a potential increase in spreads, suggesting a cautious approach towards corporate debt investments.