Yesterday, I outlined three sectors -- real estate, utilities, and energy -- that would underperform if the market took another leg down this fall and that investors looking to free up some cash should consider selling. Today, let’s look at the other side of that coin and identify three sectors that you might consider buying in a falling market.
The thing is, if weakness in stocks does come over the next few months, it will be a different kind of drop, based on a different set of economic circumstances than anyone is used to. It will be in response to rate hikes, which have been ongoing, but we still have strength in the labor market, and consumer spending has moderated a bit, but is mostly holding up well. Most of all, we still have inflation at 1980s levels. Those are unique circumstances, and any selling will be based on the fact that the Fed has effectively said that they will keep hiking rates until it is obvious that they have gone too far.
That is what their stated reliance on three-month averages of backward-looking data actually means. By the time real weakness appears in the numbers, the damage will have been done and will be hard to undo. That is basically what has happened over the last year or so, but in the opposite direction. Everyone who has gone shopping knew there was inflation, but the Fed’s insistence on waiting until the average of their preferred indicator, CPE, had confirmed that for several months in a row meant that they came late to the party in terms of reining that inflation in.
And yet as they prepare to reverse that policy, they are still saying that they will take the same approach. They acted late last time and are now telling us that they will do so again. That said, maybe I have too much faith in Powell and the rest of the FOMC, but I think there is a chance that no matter what they are saying right now, they won’t actually repeat the same mistake. Even if they know in their heart of hearts that they will have to ease up on the hikes early, they have no choice but to say their decisions will be “data-dependent.”
That may suggest that they will be behind the curve again, but from an image perspective it is better for a central bank to suggest that than to say, “Trust us! We're going to wing it, but we'll probably get it right!" Given their recent experience, though, that may be closer to what actually transpires.
It is likely that what we will be dealing with over the next few months is market weakness in anticipation of a recession that may not happen, while inflation continues to put upward pressure on prices, and with the rate hikes that are prompting the weakness ending sooner than anticipated. As I said, a unique set of circumstances, but there are some areas of the market that could outperform in that scenario.
The first, healthcare, is a traditional defensive sector for investors. The assumption is that it is the last thing people cut from their budgets but as we saw in 2008/9, it is not a place to hide in a full-on recession with massive job losses that lead to a high number of personal bankruptcies. In this scenario, though, that isn’t likely what we are going to see, and healthcare spending should remain at or close to recent levels. It is not an industry that is unduly affected by rising rates either, so could escape a rate-hike-driven downturn relatively intact.
The same logic goes for another traditional defensive play, consumer staples. Talk of recession will cause consumers to cut back on or cut out some luxury items, but until one actually comes, that will be the limit of most people’s spending adjustments.
The third sector I like in a rising rate environment without too much economic damage is financials. Banks and insurance companies actually benefit from rates moving higher and if, as posited, that is a short-term thing that is halted before any real damage is done, other areas of their business such as consumer banking and business lending will hold up well. The market declines that will accompany rate hikes may hurt from a wealth management income perspective, but any buying would be on an assumption that markets will bounce back, so that would be considered only a temporary issue.
Healthcare, consumer staples, and financials are all sectors that won’t get too badly hurt by rate hikes, where revenues can be expected to be little impacted by the fear of a recession that those hikes will engender. Then, should the Fed to do the right thing and learn from their mistakes, they will be ideally placed to bounce with everything else. That gives all three sectors some downside protection but still with upside potential, and that is what investors should be looking for as they buy on dips this fall.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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