With a potential recession looming over global markets, many investors will be worried about how a slowdown in the economy will impact their portfolios.
The June edition of the Bank of America Global Fund Manager revealed that a net 62% of investors expect a weaker economy in next 12 months. Some 64% anticipate a ‘soft landing’ (or an economic slowdown that avoids recession), 26% see a ‘hard landing’ (or a slowdown that leads to recession) and just 3% expect ‘no landing’ at all.
But Maddison Faller, head of market intelligence at JP Morgan, highlighted several steps investors can take now to strengthen their savings in a recessionary environment, starting off with equities.
Many investors have lowered their equity exposure amid the volatility of recent years, but Faller said now is the time to take advantage of low valuations and bolster exposure to stocks.
“Stocks are the engines of capital appreciation in portfolios,” she said. “When investors are fearful and markets dip, that’s often the time to pounce and use volatility to rebuild positions.”
The S&P 500 index dropped 8.3% in 2022 but it has rebounded 16.6% over the past year, nearing a point that could signal a positive sign for future return.
When the S&P 500 rallied 20% after the past 11 bear markets, the index climbed an additional 22% the following year.
US bear markets (S&P 500) and recessions
Source: JP Morgan
Despite this appealing outlook, Faller’s clients have been net sellers of equities in 23 of the past 30 weeks, leaving most of them with a lower allocation to equities today than they had a year ago.
“It might not be all smooth sailing (we expect volatility ahead), but we think the worst is over for stocks,” Faller said. “When stocks have rebounded that much from their nadir in the past, it’s boded well for future returns.”
Now may be an opportunistic time for rebuilding equity exposure, but Faller said investors should be carefully considering how much they are exposed to individual holdings.
One bad performing stock can drag down the overall return of a portfolio if the position is overly concentrated.
For example, the Russel 3000 was down 12% from its highs of 2021 but one in every four stocks in the index dropped more than 75% over the same period.
A high allocation to one of these stocks would have been a significant detractor to a portfolio, which “serves as a warning against putting all your eggs in one basket,” according to Faller.
“While concentrated stock positions can create substantial wealth, they also come with a high probability of dramatic losses that can potentially derail the financial future you had envisioned for you and your family – especially during times of volatility,” she added.
Sometimes investors can be reliant on one stock without knowing it if it is a top holdings across several funds they hold, so it is worth checking stock allocation across portfolios broadly.
Broadening equity exposure may be one way investor’s can defend their portfolios ahead of a recession, but Faller said there are ways to offset risk by diversifying across asset classes too.
Whilst many investor are using cash as a safety net, now is the time to be using bonds instead. Approximately 25% of Faller’s clients’ investable assets are held in cash or cash-like instruments, but she said they are better off reinvesting that in bonds.
With inflation falling and interest rates close to stopping, the high yields available on fixed income assets are “likely at or near their peak for this cycle”, according to Faller.
“Reinvestment risk should be top of mind,” she said. “Now is the time to extend duration and lock in elevated yields for longer.”
While investors are considering their asset exposure, it may also be worth looking at their regional exposure too.
Faller said investors often have a bias to their home market that can close them off to better opportunities in other parts of the world.
“You probably stay too close to home with your investments,” she said. “Half of our US clients are materially underweight Europe,and two-thirds have little to no exposure to China.
“That may have been a good bet in years’ past, but such positioning could leave investors wrong-footed as the tide turns.”
Many UK investors might overlook China in favour of holdings closer to home, but Faller said it could pay off to shred domestic biases and look further afield.
Although China remains “a tough call,” Faller said that its potential to “propel markets” through the second half of the year means it should be on investors’ radars.