S&P and TSX positioning as the cycle winds down

Portfolio positioning as the market winds down should be based on whether a recession is six months away or not. That’s because research reveals that equities perform most poorly during this period.

That conclusion comes from a weekly market report from Richardson GMP assessing the 11 recessions since the 1940s.

“In six of the eleven recessions, the S&P 500 rose,” says the report. “In many cases most of the pain is felt before the recession actually begins,” with price returns averaging -3.2% in the six months before the recessions. That performance is indicative of equity markets tending to be forward looking, especially compared to economic data, says the report.

Outside of those six months, however, markets tend to be strong, revealing that the late stages of a bull market can be very profitable, “especially the 12-24 months before the recession starts,” says the report.

Results for the TSX were even better during those periods.

“Our market, with its more resource bent, has greater exposure to what many investors term late cyclicals, including energy and materials,” says the report. “However, our market starts to lose momentum earlier, not doing well during the last six months and also the six months beforehand.”

Further, the TSX didn’t do as well during the recession, which could be attributed to its greater leverage to global economic growth, says the report.

The firm also assessed 10-year bonds before the recessions, which proved to perform poorly (rising yields) in the last stages of a bull market (six to 24 months before a recession). But bonds “start to perform their capital preservation function in the last six months and into the recession,” says the report. “Just in case you forgot why you own bonds (or should own bonds).”

Are we there yet?

In assessing whether we’ve arrived at the critical six-month point before the potential next recession, Richardson GMP employs a market cycle framework comprising more than 30 indicators from various disciplines, including technical, economic, valuations, fundamentals and sentiment.

“Currently, 21 of the 30 indicators are bullish, which is well above the recession warning threshold of around 10,” says the report. “But it is worth noting the number of positive indicators was a healthier 26 at the end of 2017, so we have seen some deterioration.”

That means that, though global economic data are losing some momentum, there’s no cause for concern yet.

Says the report: “Given our indicators remaining bullish, we continue to view the recent weakness as a normal correction and not the beginning of a bear.”

Putting analysis into action

Summing up his current outlook in weekly market commentary, Richard Turnill, BlackRock’s global chief investment strategist, says, “We see a conducive backdrop for risk-taking ahead, despite higher economic uncertainty.”

He’s positive on U.S. equities over a three-month time horizon based on strong earnings momentum. “We like the momentum and value style factors, as well as financials and technology,” he says.

Read: Why Canadian investors need more technology exposure

He notes that flows data, as well as his proprietary data on investor positioning, show that U.S. equities have taken a particularly hard hit since January, suggesting room for a rebound. “Investors seeking to play defense in equities should look to companies with strong free cash flow and the ability to boost dividends rather than seek high dividends alone,” he says.

As S&P companies begin reporting first-quarter results, he says to look for “signs of non-tax-related measures of corporate strength, such as sales and how corporations are spending their cash windfalls and adapting to trade tensions.”

He’s also positive on emerging markets, based on economic reforms, improving corporate fundamentals and reasonable valuations. “We see the greatest opportunities in EM Asia,” he says. “We like Brazil and India, and are cautious on Mexico.”

Read: Country of the month: Mexico

In fixed income, “high-yield funds have bled assets, while U.S. investment grade, EM debt and U.S. government bonds have attracted inflows.” Specifically, he says short-maturity Treasurys offer a “compelling risk/reward proposition.”

For full details, read the reports from Richardson GMP and BlackRock.

Also read:

Real asset outlook as U.S. rates rise