Recession will be the main focus in Q3
Government bonds, US growth stocks and consumer staples are all ideal assets to hold as a recession becomes an increasing likely reality, according to experts across the industry.
Recession is a growing market concern as central banks juggle slowing growth and rising inflation.
Indeed, the US is technically already in a recession after experiencing two consecutive periods of negative economic growth, although the National Bureau of Economic Research has yet to declare it.
Ben Laidler, global market strategist at eToro, said: "The world is now shifting and while inflation was the story of Q2, recession risk is very much the main third quarter narrative."
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A recession has a tangible market impact, and Dan Kemp, global CIO at Morningstar, said that a mild recession has already been priced in. According to Kemp, investors now need to assess the scope the impact could have on their portfolios.
"Big economic events like recession are incredibly dangerous for investors because they bring out all of our behavioural biases and encourage us to focus on the short term," he explained. "From our perspective, it is all about building a robust portfolio that includes lots of different features, not just the one, and knowing what is priced in."
Constructing a portfolio with a recessionary backdrop involves a high level of diversification, according to Kemp.
US tech
Among equities, investors may want to reconsider US growth tech stocks.
This section of the market has taken a big hit from the levels of rising inflation and the general shift towards value and cyclical sectors, such as commodities and industrials, which tend to perform better during periods of higher inflation.
But the assets which do well to hedge against inflation are not necessarily the ones investors need to be holding for a recession, and Laidler said the big US names could actually be ideal holdings should the latter take place.
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"The big tech names have these bulletproof balance sheets, shored profit margins, massive cash flows and basically no competition; they are absolutely going to survive this recession."
Laith Khalaf, head of investment analysis at AJ Bell, agreed that many of these stocks were "resilient businesses with a lot of resources".
"Amazon, Microsoft, Apple are not going away," he said, adding these companies would still be capable of growing earnings long-term.
The sentiment around these stocks has improved in the last few days as US inflation numbers stabilised, with the tech-heavy Nasdaq Composite index closing today (11 August) more than a fifth above lows seen earlier this year.
But the question of valuations looms over this sector and Ben Yearsley, co-founder of Fairview Investing, questioned how much protection these stocks could provide given valuations have already come down significantly this year.
Consumer staples and utilities
According to Yearsley, defensive assets such as healthcare and utilities form part of a recessionary basket.
Essential areas such as supermarkets would have been an obvious allocation in the past but with a cost-of-living crisis causing a squeeze on consumer liquidity, Yearsley said this type of holding is under pressure.
A company's ability to sustainably maintain its earnings was a core focus for David Henry, an investment manager at Quilter Cheviot, when considering what to hold in a recession-proof portfolio.
He said: "A business that can maintain earnings growth during the coming period will likely be disproportionately rewarded by the market," and agreed that "to an extent, we can already see this playing out during the recent earnings season".
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Companies which rely on consumers spending on big ticket items such as Made.com and Wickes are already struggling, whereas Unilever, with its wealth of staple brands, would fare better.
Government bonds
Outside of equities, many of the experts were bullish on government bonds.
Morningstar's Kemp said: "We think it is time to maintain your confidence in government bonds as the most, most reliable source of protection."
While fixed income has been the traditional diversifier to equities over the past few months, the negative correlation between the assets has broken and the assets have been moving in lockstep.
"But this is not the first time this has happened," Kemp added. "The fact that we can actually remember in recent history when this last occurred should remind people that this does happen and is normal."
Indeed, within the past month this relationship has normalised as government bond yields have declined on the back of recessionary worries.
"We can see that the government bonds are over the long term your best friends if you are still concerned about the economic risks," Kemp said.
He stressed that what then becomes important is the quality of the bond itself.
"You are effectively paying for insurance so you have got to have the highest quality insurance you can."
Overall, many of the experts urged investors not to cash out entirely and remain invested, even if it felt tough in the coming months.
Quilter Cheviot's Henry said: "A recession is not cause in and of itself to abandon your investment plan - recessions are a natural part of an economic cycle and as investors we have to expect them.
"We believe however that it is prudent to take the time to understand what you are holding, and to be comfortable that the stocks in your portfolio exhibit a robustness or competitive advantage to allow them to continue to grow."
