If growth deteriorates too quickly or goes too far, then "bad news is bad news indeed," JP Morgan Chase said. Professional investors are betting that a recession can be avoided, despite warnings to the contrary. It's a risky bet — for several reasons, Goldman Sachs says in its analysis.
Fund managers prefer financially sensitive stocks, such as industrial companies and commodity producers, according to a Goldman Sachs study of the placement of Mutual funds and Hedge funds with assets totaling nearly $5 trillion.
The analysis shows that stocks that tend to do well during economic downturns, such as utilities and consumer staples, are out of favor today. The positions amount to bets that the Federal Reserve can tame inflation without creating a recession, a hard-to-achieve scenario often referred to as an economic soft landing.
The precariousness of those bets was on display on Friday (12/2) and Monday (12/5), when strong signs on the US labor market and services sectors led to speculation that the Fed should maintain its hawkish policy, increasing the risks of a policy error. Current sector tilts are consistent with positioning for a soft landing, and fund industry thematic and factor reports indicated a similar stance.
But who takes the risk? It's not that smart money that has taken the risk. They have increased cash holdings or strengthened bearish bets on stocks this year as the Fed launched its most aggressive campaign to fight inflation in decades. But beneath the defensive stance is a cyclical tilt, which runs counter to widespread concerns in the investment community that a severe economic downturn is on the horizon.
In a Bank of America poll of fund managers last month, 77% expected a global recession in the next 12 months, the highest since the immediate aftermath of the 2020 crisis. Professionals are likely to be slow to adjust their portfolios to reflect perceived financial risk. Or they seek recession protection through other strategies, such as holding money in cash. A more plausible explanation is linked to hopes that the Fed will be able to drive a soft landing.
In this case, the bad economic news is seen as suitable for the market as it shows that Fed Chairman Jerome Powell's campaign to fight inflation is working. Therefore, policymakers can curb the aggressive pace of interest rate hikes. The narrative, described as a Fed pivot, is widely cited as why the S&P 500 has rallied more than 10% from October lows despite worsening data in sectors such as housing and manufacturing and a decline in earnings estimates.
But now, the opposite is happening. Stocks fell on Monday after an unexpected rise in a US services index fueled fears that the Fed may have to stick with its "aggressive" stance. Hence, the upcoming sessions will show us what will happen.