Is the United States heading toward a recession?
This has been the looming question on the minds of Americans since inflation topped at 8.5% in March, matched with other indicators such as rising interest rates and the bond market’s inverted yield curve.
Top economists are split on the inevitability of a recession. Former Goldman Sachs Group Inc (NYSE:GS) CEO Lloyd Blankfein said over the weekend, “It’s certainly a very, very high-risk factor,” but believes that the Fed is responding well to the risk.
Moody’s Corporation (NYSE:MCO) chief economist Mark Zandi predicted a 35% probability that America will enter a recession in the next two years. Twitter Inc.'s (NYSE:TWTR) most-loved Elon Musk predicted a recession as early as the summer of 2022.
Conflicting outlooks aside, it is essential to look at the facts and what has historically preceded a recession.
The yield curve inverted on March 29 for the first time since 2019. This occurs when the short-term U.S. treasury is paying a higher interest rate than long-term U.S. treasuries. More than that, Fed Chair Jerome Powell indicated a 50 basis point increase, up from the traditional 0.25% at the last FOMC (Federal Open Market Committee) meeting.
The known definition of a recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. According to the Bureau of Economic analysis, the GDP decreased at an annual rate of 1.4%, down from 6.9% in the fourth quarter of 2021.
While the macro outlook is pessimistic at best, it is critical to understand the broader market trends that indicate where money moves, such as the economic cycle and sector rotation.
It is known that a recession is a natural part of a growing economy and as part of the economic cycle. The cycle can be simply defined as when the economy moves from a growth stage to a recession and back to growth. This is probably the most influential force on the broader markets because it directly relates to stock prices vis-a-vis company profits.
The stock market's relationship with the economic cycle lies in the various sectors that make up the markets, which are sensitive to different stages of the cycle.
Are you confused yet? This should make it easy.
Some sectors will outperform when the economy is growing (Industrials, Consumer names, Real Estate) and others when the economy is in a recession (Healthcare, Food, Consumer Staples, Utilities)
This is known as sector rotation or the way investors move money during the various stages of the economic cycle.
When the economy moves toward a recession, investors usually rotate into sectors that are less sensitive to the economic cycle, such as Consumer Staples and Utilities; these are known as defensive sectors because they can offer a relative level of protection during an economic downturn.
Some of those defensive names include:
Coca-Cola Co (NYSE:KO)
Albertsons Companies Inc (NYSE:ACI)
Altria Group Inc (NYSE:MO)
NRG Energy Inc (NYSE:NRG)
PG&E Corporation (NYSE:PCG)
Clearway Energy Inc (NYSE:CWEN)
National HealthCare Corporation (NYSE:NHC)
HealthStream, Inc. (NASDAQ:HSTM)
Regencell Bioscience Holdings Ltd (NASDAQ:RGC)
On the opposite end, when emerging from a recession, investors rotate into highly sensitive names to the cycle, such as Industrials and Consumer cyclicals.
Read also: NYSE Or NASDAQ? Here's Why Stocks Get Listed There
Some of those names include:
Caterpillar Inc (NYSE:CAT)
Johnson & Johnson (NYSE:JNJ)
Ecolab Inc (NYSE:ECL)
Chevron Corp. (NYSE:CVX)
Tesla Inc (NASDAQ:TSLA)
JPMorgan Chase & Co. (NYSE:JPM)
Boeing Co (NYSE:BA)
Mastercard Inc (NYSE:MA)
