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JPM AM: eight portfolio ideas to get ready for recession

JP Morgan global market strategist Mike Bell has some advice on how to prepare for the end of economic growth.

Nothing lasts forever, and the the current US recovery – now the second longest in history on some measures – is no exception.

But with the Fed beginning to end a decade of easy dollars, there are ways to prepare for a much less accommodative environment. 

JP Morgan global market strategist Mike Bell has some advice on how to do just that. We present eight of his late cycle ideas.

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Nothing lasts forever, and the the current US recovery – now the second longest in history on some measures – is no exception.

But with the Fed beginning to end a decade of easy dollars, there are ways to prepare for a much less accommodative environment. 

JP Morgan global market strategist Mike Bell has some advice on how to do just that. We present eight of his late cycle ideas.

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Move toward equity neutral but stay invested

'In the run-up to the start of a US recession, equities can deliver strong positive returns.

'This highlights the risk of going underweight equities too early. For example, an investor who called the dot-com bubble too early would have missed out on a return of 39% in the final two years, or 19% in the final year of the S&P 500 rally.

'Once the market starts to price in recession, though, equities struggle. Markets have peaked anywhere between zero and 13 months prior to the start of a recession.

'Given the difficulty of precisely timing market peaks and troughs, investors may want to consider moving closer to neutral in equities in the late stage of the economic cycle.'

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Stay regionally diversified

'A shift in regional allocation rarely helps cushion performance in a market correction.

'Investors concerned about a potential recession in the US may be tempted to shift away from US equities into other equity markets, but during US recessions stock markets in all regions tend to fall – sometimes by more than US equities.

'When you add in the fact that the dollar appreciated during the last two recessions, it’s far from clear that concerns about a US recession should lead investors to shift from US equities into other equity markets.

'Investors are normally better off maintaining a regionally diversified portfolio.'

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Avoid small and mid caps

'Small-cap stocks tend to underperform the market during recessions, particularly in the UK.

'Between May 2007 and December 2008, UK mid-cap stocks underperformed the FTSE 100 by 18% and have since outperformed by 200%.

'The average UK equity fund has over 40% in mid- and small-cap equities, which is over 20% more than the FTSE All-Share.'

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Value's time to shine?

'Growth stocks have often underperformed value stocks during S&P 500 bear markets.

'The obvious exception was the global financial crisis, when value underperformed, although this was because of the high weighting of financials in the value index during a crisis in the US financial system.

'With banks much better capitalised now than they were prior to the last downturn, the next recession is more likely to be a 'normal' recession and less likely to turn into a financial crisis.'

 

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Add quality and value

'Value stocks have tended to strongly outperform growth when the period preceding the downturn saw a significant rise in the relative performance of growth stocks, such as during the dot-com bubble.

'Quality stocks (defined here as those with high profitability and earnings quality and low financial risk, with a focus on strong cash flow generation) are the only investment style that have outperformed the index in every recent downturn.'

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Stay flexible on fixed income


'With interest rates still at very low levels in many economies, an ability to shift across regions is critical to take advantage of government bond markets where there is scope for central banks to cut rates and to avoid those markets where the sustainability of government debt could come into question during a downturn.

'Credit sometimes starts to underperform government bonds before equities peak. Strategies that seek to dynamically reduce credit risk and increase duration as recession risk rises can help to buffer portfolios.'

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Hold cash, not duration

'Holding cash in recent years when real rates were negative didn’t make much sense.

'But as a tactical allocation, cash or liquidity instruments can add ballast to a portfolio and help investors feel comfortable maintaining some allocation to risk elsewhere in their portfolios. In the US, where rates have risen, real yields have improved.

'The curve has also flattened so investors who are concerned about duration risk, resulting from the potential for further rate increases in the near term, can get almost as much yield on short-term liquidity instruments as on a 10-year Treasury.

'Obviously, investors would also need to consider currency risk if investing outside of their home currency.'

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Look for genuine diversifiers


'Strategies with the ability to lower their correlation to risk assets can help buffer portfolios in a downturn.

'Some examples include macro funds and equity long-short funds, particularly those with the ability to take their net equity exposure to zero.

'Investors should be aware, though, that some equity long-short funds have a structural positive, albeit lower, beta to equity markets.'

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