The U.S. economy is on pace for its fastest year of growth since 2015, but investors shouldn’t let this fact blind them to the coming slowdown, according to Russ Koesterich, portfolio manager for BlackRock’s Global Allocation Team.
In a blog post published Thursday, Koesterich pointed to a series of worrying indicators that show that the best of the current economic cycle is behind us, arguing that these should convince investors to revise their portfolios and take a defensive stance.
The first such indicator is the trajectory of global manufacturing activity. “It now looks even more likely that global manufacturing peaked in early 2018,” Koesterich wrote, adding that weakness in Europe and Asia has now spread to the U.S.
“The ISM New Orders Index, a good leading indicator for manufacturing and the broader economy, is slipping: It is now at its lowest level in 18 months, before the “sugar-high” of last year’s tax cut,” Koesterich noted.
BlackRock
On top of these foreboding trends, financial conditions continue to get tighter, as measured by the Goldman Sachs’ Financial Conditions Index, and not just because the Fed has been raising short-term interest rates. In addition, “a stronger dollar, a more volatile stock market, and less benign credit market” means there is simply less money floating around to power corporate profit growth.
Meanwhile, the U.S. housing market continues to weaken, and this is bad for more than just the beleaguered home builders. Because new home purchases drive all sorts of other spending, on things like furniture, home improvement services, and fees for brokers and lawyers, the state of the housing sector tends to have an outsized effect on the rest of the economy, Koesterich argued.
Finally, investors must take stock of the obvious shift in sentiment that the above factors are driving. You can make the case that the U.S. economy is healthier today than it’s been in years, but the “problem,” according to Koesterich is that this “is probably as good as it gets for a while,” and that “a growing conviction in a slowdown is clear in recent investor behavior.”
A sector-by-sector look at recent stock performance shows this growing conviction clearly. Over the past three months, defensive stocks that tend to perform better during economic slowdowns, like the health care sector and utilities sector, has outperformed cyclical sectors, such as energy, materials and technology. For instance, the Utilities Select Sector SPDR Fund
XLU, -0.62%
has gained 1.2% over the past three months, while the Technology Select Sector SPDR Fund
XLK, -0.97%
has lost more than 10%, according to FactSet.
So how should individual investors respond to this changing sentiment? Koesterich advises they get defensive themselves, by purchasing stocks with lower beta, or those who’s price changes are less correlated with those of the overall market.
Another way to make sure you’re invested in companies that can perform well during a slowdown, or even a coming recession, is to invest in so-called “quality” stocks, or companies with “low leverage and the ability to maintain pricing power and earnings,” he writes.
And in recent weeks, quality has been a factor investors could rely on to beat the broader market, as iShares Edge MSCI USA Quality Factor ETF
QUAL, -1.00%
has lost 3.2% month-to-date, compared to a 3.8% decline for the broader S&P 500
SPX, -1.23%
.
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