Don’t bet on a soft landing
The S&P 500 returned nearly 20% in the first half of the year. It looks like the party is over though as most of these indexes have started to shed their gains once again.
The Russell 2000 has sold off 10% since August began, and the S&P 500 and Nasdaq are both down 5%. And mostly it’s for one reason.
The market is finally starting to listen to the Fed.
The Fed is serious about bringing inflation to its long-term target of 2%. It paused on hike rates this time, but another hike rate seems likely before the end of the year.
The Fed is openly saying that interest rates are going to be higher for longer. Jerome Powell seems to think interest rates will be above 5% until the end of 2024, at least.
And they don’t expect rates to come back down to manageable levels until they’re sure that inflation has vanished. That might not be until 2026.
Given this economic outlook, strategists at Bank of America, JPMorgan, and Morgan Stanley have changed their stances. A “soft landing” where we avoid a recession isn’t likely. Strategists are now predicting a hard landing.
When you have that kind of outlook, it’s brutally difficult to pick a good investment strategy.
Today, we’ll discuss what types of assets are best suited when we all but know a recession is on the horizon.
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Remember, a hard landing is just the modern language for a recession. And when it happens, one other thing is pretty much guaranteed to happen, a bear market for stocks.
When the dot-com bubble burst, the S&P 500 dropped 49% from its all-time high.
In 2008, it dropped 57%.
And during the pandemic, stocks lost over 30% in just a month.
All the major indexes seem to be catching on. That could be a sign that the market is starting to roll over.
Since 1950, bonds have crushed stocks during recessions.
Bonds differ from stocks in that they offer fixed interest payments over their duration. And at the end, you’re guaranteed to get your original investment back. This predictable income stream acts as a buffer against market uncertainties.
Bondholders are also positioned higher up in the hierarchy of financial claims. This means they get priority over stockholders in the event a company goes bankrupt.
Unlike stocks, all of this is protected by legal contracts. Once you buy a bond, you know exactly what your return will be as long as the company stays afloat.
This legal assurance of payment, combined with regular interest income, makes bonds a reliable and far more defensive asset.
That’s why bonds have returned over 10% per year during the last 70 years of recessions while stocks fell.
Bonds aren’t just risk-averse, they are highly profitable as well.
While folks typically think of bonds as low-risk, low-return, that’s not always the case.
These panic times create opportunities for double-digit yields in bonds and sometimes triple-digit gains.
When the stock market panics, many others briefly follow suit. That means bond prices can plummet.
This creates an environment where perfectly safe bonds can be bought at significant discounts.
But as we mentioned, bond investors know exactly how much they’ll get paid ahead of time.
Furthermore, if the market’s sentiment eventually stabilizes or if the issuer’s financial health improves, bond prices can rebound sharply.
So, while we still might have some time before the hard landing is here, we’d recommend you familiarize yourself with how bonds work.
It’s the perfect time to understand the landscape. When we officially enter a recession, there will be plenty of cheap, safe bond opportunities to keep your portfolio happy.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research