As Wall Street economists and central bankers continue to debate the possibility of a recession in the US, big money managers are shifting their investments away from economically sensitive shares such as banks and towards stocks that are resilient during economic downturns, such as utilities and consumer staples. This defensive posture is a departure from last year when active funds were hanging onto a cyclical tilt and signaled faith in the Federal Reserve's ability to engineer a soft landing.
The data on sector positioning compiled by Bank of America shows that hedge funds that make both bullish and bearish wagers have cut their cyclical holdings versus defensive equities to the lowest level since at least 2012. For long-only managers, their relative exposure to cyclical companies is near the lowest level since 2008.
All told, active stock pickers are "positioned for a 2009-style recession," according to BofA strategists led by Savita Subramanian. This growing pessimism in the world of active investing is highlighted by the recent preference for defensive equities, despite a rally that has added $5 trillion in equity values since the market's October low.
The defensive posture can set the stage for big rallies when bears are compelled to chase gains, worried about being left behind. However, bears attributed a big part of the equity rally to those price-insensitive quant investors who have no choice but to buy stocks when prices go up, warning the multi-month advance is unsustainable.
While companies have delivered results above estimates this reporting season, it's not enough to send corporate America back to the growth track, at least not yet. Even Fed officials predicted a "mild recession" starting later this year.
However, history shows that getting too early into defensive positioning in preparation for a recession may end up being costly. Tracking stock performance based on their historic sensitivity to economic growth, BofA's Subramanian's team found that the 10 most-cyclical industries tended to outperform in the six months leading up to a recession. It's not until during the actual recession that defensive shares started to shine, although their leadership usually reversed before the end of the down cycle.
"When it comes to recessions, don't anticipate. Wait," said Subramanian, adding that BofA economists see a US recession starting in the third quarter.
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