Economists and strategists on Wall Street are increasingly asking not if, but when, a slowing global economy will accelerate into a more severe downturn.
Amid calls for slowdowns in major economies, along with lingering political uncertainty and central banks’ unwinding accommodative monetary policy, some macroeconomic experts are recommending that investors bulk up on defensive assets.
“Strategically, we recommend investors increase portfolio defensiveness,” a team of Goldman Sachs strategists led by David Kostin told clients in a note on Monday. “Cash allocations are at or near the bottom of their 30-year historical distribution for many investors.”
Investors may wonder what defensive means, especially in a challenging market like last year’s, where few trades worked out. Investors across markets and asset classes mostly counted 2018 as a loss, and cash became more attractive as equities around the world languished.
Kostin and his team said investors should consider stocks positioned to outperform in an “uncertain economic environment” and came up with a list of 30 names that would still boast an above-average valuation even if earnings were to sharply decline. They included stocks across traditionally defensive sectors like industrials and consumer staples, including the likes of FedEx, Raytheon, Kroger, and Philip Morris.
Others say even as positive growth is still expected for this year, a more conservative approach is prudent.
A team of strategists at AllianceBernstein told clients Monday that while several indicators — including the flattening yield curve, a downturn in key US service sector data, and Economic Surprise Index data — supported the view that economic growth was indeed slowing, analysts were expecting positive earnings growth for this year.
“We face a slowing cycle with growth slowing in most regions, though the timing and pace of the slow-down differs by region,” the team led by Inigo Fraser-Jenkins wrote.
“Monetary policy is also becoming less accommodative in most regions. Against this backdrop we have a somewhat defensive factor allocation, but we retain some cyclical exposure as despite the headwinds we think that growth will still be positive in 2019.”
Specifically, AllianceBernstein is recommending that investors buy companies with qualities like low debt-to-equity ratios and those with high levels of free cash-flow yield. Such a measurement of companies’ “quality” tends to be less correlated with political risk, the strategists said.
Meanwhile, Bank of America told clients in a note that investors’ exposure to “low quality” was a key risk this year.
“Managers have historically been overweight Low Quality (B or worse S&P quality rank) stocks,” strategists led by Savita Subramanian wrote in a report out Monday.
“Their bias towards lower quality is a key risk in our view, particularly heading into the new year where we expect volatility to remain elevated.”
Among traditionally defensive sectors, the bank said active managers last year pared their holdings in consumer staples, a traditionally defensive group, and rotated into healthcare.
But that development in and of itself could be reason enough to lighten up on defensive names. Historically, when the healthcare sector reaches 15.6% of the S&P 500, which happened in mid-December, it begins underperforming and the broader market starts bottoming out, according to an analysis from DataTrek Research.