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  • Data is mounting a recession is on the horizon.
  • Early-cycle sectors were among the worst-performing sectors during the 2008 and 2009 bear market.
  • Many surprising sectors began outperforming months before the low in 2009.

Disappointing first-quarter results posted by big retailers this week are the latest evidence suggesting a hawkish Fed is pushing the U.S. economy into recession. As Action Alerts PLUS pointed out yesterday, inventories have suddenly become too big, and as Walmart and Target indicated in their earnings calls, consumer spending is increasingly tilting toward necessities like food.

Bloated inventories could be why Freightwaves began warning that transportation companies were rejecting fewer freight offers in March, suggesting weakness. In April, the Cass Freight Index declined 3.5% month over month, slipping 0.5% year over year, prompting them to write, "the prospect of freight recession is now considerable…the freight cycle has downshifted with a thud." Last week, Freightwaves said, "shipment volumes are unseasonably low in the run-up to summer shopping," so the situation isn't getting better.

Consumers' shift away from discretionary buys is understandable because inflation has risen faster than wages for thirteen months. 

A tapped-out consumer

Unsurprisingly, Equifax said this week that subprime borrowers are having a tough time making payments. 

Over half the population lives paycheck to paycheck, and most carry larger revolving balances than they were a few months ago. Moreover, given variable interest rates on credit cards are climbing, additional interest rate hikes could mean delinquency and default rates worsen.

In "Consumer Confidence Is Shot," Real Money Pro's Bret Jensen sums the situation up this way:

“Inflation has come in over average wage gains in this country for 13 straight months now. This has led to the worst consumer confidence levels in more than a decade, and a big reason more than three-quarters of those polled believe the nation is heading in the wrong direction. Hardly a positive omen for consumer spending and confidence in the coming months.

The fact is that the consumer is tapped out.”

For many Americans, wages still support spending. However, cracks are forming, and a significant percentage of the population faces tougher choices. According to Nerd Wallet, about one-third of households earning less than $100,000 per year said in November that their financial situation had worsened in the past year. If this survey was done today, I suspect the response rate would be even more discouraging.

Back to Jensen:

“At some point a good portion of the consumer base is going to have no choice but to hunker down and curtail spending to just the essentials. Consumers are not alone in their pessimism. According to a new Conference Board report, CEO confidence is now negative for the first time during the economic expansion with 68% of leaders surveyed projecting that current Fed policy is going to trigger a recession.”

The best and worst stocks to buy

If a Recession is a certainty, investors may benefit from studying past recessions for clues to what sectors and stocks do better or worse than the market when GDP is falling.

Unfortunately, the TL: DR is that if the bear growls as fiercely as it did during 2008 and 2009 (the most recent, long-lasting downturn), there won't be anywhere to hide besides Treasuries and cash.

The following table shows returns for many commonly held sector and industry ETFs from Dec. 31, 2007, through March 6, 2009 (the last close before the S&P bottomed on the 9th). As you can see, they're all in the red by double digits.

I've mentioned the economic cycle in the past. The recessionary-stage baskets did better than early cycle groups in 2008 and 2009, and they produced significant relative to the S&P 500, but healthcare, utilities, and consumer goods still posted substantial double-digit losses.

TABLE-Street-Smarts-0520

The Smart Play

Recessions aren't identical, but they can rhyme. Of course, the timelines can be shorter or longer, and not every basket will perform precisely the way it does "on average."

Nevertheless, history is our best guide, and probabilities help us navigate markets by showing us where we're likely to have the most success. For this reason, focusing on the business cycle can be wise.

CHART-Business-Cycle-0506

Remember, though, that the market is forward-looking. It anticipates each stage, which means stocks within sectors that do best in the upcoming stage can begin improving beforehand.

For example, the following table includes the same table I shared above, plus a new table displaying performance for those ETFs from Dec. 31, 2008, through March 6, 2009. As you can see, many defensive sectors still outperformed up to the absolute market bottom, but some early-stage groups, including retail and technology stocks, delivered even better relative year-to-date returns.

TABLE-Street-Smarts_2_0520

Again, results may vary, and not every recession plays out the same. Nevertheless, the possibility that early-cycle baskets begin outperforming before the market puts in its absolute low suggests you'll want to keep those sectors on your radar. If data shows inflation is getting back under control and as a result, the Fed's likely to become less, rather than more, hawkish, you'll want to be able to increase your exposure to those stocks accordingly.

  • Data is mounting a recession is on the horizon.
  • Early-cycle sectors were among the worst-performing sectors during the 2008 and 2009 bear market.
  • Many surprising sectors began outperforming months before the low in 2009.
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