Investors are eyeing everything from the US healthcare sector to UK stocks and gold as potential havens during a recession, as worries grow that the Federal Reserve's interest rate increases will bring on an economic downturn next year.
Gloomy year-ahead forecasts from Wall Street banks have piled up in the past week, although a strong November jobs report released on Friday undercut the case for an imminent slowdown in the US economy.
JPMorgan, Citi and BlackRock are among those who believe a recession is likely in 2023. While a downturn is not assured, strategists point to the Fed's hefty monetary tightening, a steep slowdown in the housing market and the inverted Treasury yield curve as reasons to expect that growth will stall.
Recessions are usually bad news for stocks, though some investors believe 2022's sharp decline in equities suggests a degree of slowdown has already been factored in. The S&P 500 has fallen as much as 25.2% from its all-time high this year, compared to an average decline of 28% the index has recorded in recessions since World War Two, according to data from CFRA Research. The index is down 14.6% year-to-date.
Nevertheless, many on Wall Street are increasing allocations to areas of the market that have a reputation for outperforming during uncertain economic times.
"When investors see a recession coming, they want companies that can generate income regardless of the business cycle," said Jack Ablin, chief investment officer at Cresset Capital, who expects a mild recession in 2023, followed by Fed easing.
In their 2023 outlook, strategists at the BlackRock Investment Institute recommended stocks in the healthcare sector, an area where demand is thought to be less sensitive to economic fluctuations. The S&P 500 Health Care sector is down around 1.7% year-to-date, handily beating the broader index's performance.
BlackRock said the firm also prefers energy and financial stocks, though it is underweight developed markets as a whole.
"A recession is foretold; central banks are on course to overtighten policy as they seek to tame inflation," the firm's strategists wrote. "Equity valuations don't yet reflect the damage ahead, in our view."
JPMorgan's analysts forecast a "mild recession" and expect the S&P 500 to test its 2022 lows in the first quarter of next year. Above-average valuations and Fed hawkishness make US stocks unattractive in comparison with other developed markets, the bank said, naming the UK as its top pick.
BoFA Global Research expects US equities to end broadly flat in 2023 but sees prices for gold rallying up to 20%, aided by a falling dollar. Raw materials such as gold are priced in dollars and become more attractive to foreign buyers when the greenback declines.
Citi, meanwhile, said recession fears and weaker earnings growth will hurt US stocks in 2023 and advised clients to "treat rallies in US equities as bear market rallies." By contrast, they are overweight China, expecting Chinese stocks to receive a boost from loosening Covid-19 restrictions and government support for the real estate sector.
Fourth-quarter earnings for the S&P 500 are expected to fall 0.4% compared with the same time period last year, before rebounding over the course of the year and hitting a 9.9% growth rate in the fourth quarter of 2023, according to Refinitiv data.
Investors in the coming week are awaiting economic data on the US services sector, which grew at its slowest pace in nearly 2-1/2 years in October.
Not everyone believes that recession is a given. Signs of ebbing inflation have fueled hopes that the Fed may tighten monetary policy less than expected, supporting a rebound in the S&P 500 that has buoyed the index from its October low.
Lucas Kawa, an asset allocation strategist at UBS, believes stock prices are already factoring in recession risk. He expects some of the factors that hurt markets in 2022 - including weaker growth in China and Europe – to reverse next year, supporting asset prices.
"There's a good chance that 2022's headwinds are going to turn into 2023's tailwinds," he said.
Garrett Melson, a portfolio strategist at Natixis Investment Managers, expects a so-called soft landing in which the US economy grows at a moderate pace, with higher interest rates weighing on consumers without completely squashing spending.
He is bullish US small-cap stocks, which he believes have priced in a recession. The small-cap Russell .RUT is down some 16% this year.
"The market seems a little offside here with the consensus that a recession is inevitable," he said. "The path to a soft landing is probably wider than what the consensus viewpoint is right now."