Recession warnings are becoming louder as inflation remains high and the Fed faces pressure to act.There are reasons to believe a near term recession can be avoided though if certain features of the economy remain in place.The UBS CIO team has laid these out and detailed how investors should be allocating their money right now.Recession warnings are bubbling up from a quiet murmur to louder and clearer proclamations of potential trouble ahead.
Despite growing concerns around energy prices, inflation, yield curve inversion and the Ukraine war, most experts see a decent chance of avoiding a near-term recession due to strong fundamentals underpinning the economy.
The UBS chief investment officer’s team is constantly taking the pulse of the US and global economy on behalf of the bank’s clients in order to steer their investing decisions in the right direction.
The group, lead by CIO Mark Haefele, has identified three pillars of strength that could safely shepherd the US economy through these choppy waters.However, if any of these were to give way, trouble could follow.
Firstly, the strong labor market must to continue offering protection against pressures from inflation and rate rises.
“Employment data released on Friday showed the US economy created a net 431,000 jobs in March,” UBS said.”Add in upward revisions to the prior two months, and job creation was running at a robust monthly average of 562,000 in the first quarter.”
“The unemployment rate fell from 3.8% to 3.6% in March, and the labor force participation rate ticked up to 62.4%, both the best levels since the start of the pandemic.Average hourly earnings increased 0.4% month-over-month and 5.6% year-over-year, which is a solid result.Overall, the report was stronger than expected, and 2-year Treasury yields rose by 10 basis points after the release,” the team said.
Next, household balance sheets must stay healthy so that savings protect consumers from any worsening of credit conditions.
There are fears in some quarters that an overheating housing market could spell economic disaster as interest rates rise, but that is not necessarily the case, thanks to the widespread adoption of fixed rate mortgages.
“We estimate that consumers accumulated excess savings of around $2.5 trillion during the pandemic,” UBS said.”While they have been drawing this down, the latest Fed data shows household financial obligation as a percentage of income at a multi-decade low.Relatively few existing homeowners are exposed to higher mortgage rates, with Federal Housing Finance Agency data showing less than 1% of outstanding home loans are on adjustable rates.”
Thirdly, business sentiment and activity needs to remain positive, despite some “recent loss of momentum.”
“As sometimes happens, comments from the PMI survey respondents in the March ISM release felt out of alignment with a declining headline reading,” UBS said.”Demand remains robust, and the comments make it sound as if the backlog of orders had increased rather than decreased.”
“While we expect consumer spending to shift toward services in the months ahead, there is still some pent-up demand for durable goods, including autos.
Business demand for equipment should also remain strong, and we expect manufacturing output to continue trending higher.At the same time, inflation driven by manufactured goods should slow as supply-side bottlenecks ease.”
“So, while risks have increased and we advise investors to add hedges to their portfolios, our base case remains that the US economy can avoid a recession,” UBS concluded.
6 sectors to weather the storm Turning to what UBS clients and other investors should be focusing their attention on, the CIO team picked out four key tech trends to tap into.
“Recent market volatility can be used to add exposure to industries backed by long-term structural trends, such as 5G , robotics, smart mobility, and consumer experience,” UBS said.
To complement this, UBS also recommended topping up on defensive stocks such as healthcare companies , and reliable dividend payers.
“Although we have moved our preference for US healthcare to neutral, overall we continue to see global healthcare stocks as attractively priced, UBS told clients in an earlier outlook note.”Over the past 20 years, the sector has traded at an average 9% price-to-earnings premium to global equities, but today it trades at parity.
“Pharma stocks, which account for around 38% of the index, are trading at an 20% discount to the MSCI ACWI (global equities index) on a 12-month forward price-to-earnings basis, close to 20-year lows.”
“Investors can generate more stable income through higher dividend paying stocks, many of which are present in our favored sectors like financials and energy,” UBS added.”In the first year of an economic recovery, dividends have historically contributed only 8% of total returns, but this contribution tends to rise as the recovery matures.”
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