by Fidelity Viewpoints
How to find investing opportunities as recession risks rise.
Key takeaways
- Investment-grade bonds, US Treasury securities, high-yield bonds, floating-rate loans, and stocks of gold miners are among the income investments that may offer opportunities in the second half of 2023.
- Investing in a wide variety of assets may help investors meet their needs for income despite the increasing potential for an economic slowdown.
- In exchange for higher income, some assets may experience more volatility than traditional income investments.
- Professional investment managers have the research resources and investment expertise necessary to help identify opportunities and manage the risks associated with higher-yielding security types.
First, the bad news. Fidelity’s Asset Allocation Research Team expects that the US economy could slow and potentially enter a recession in the second half of 2023. Recessions are times when economic activity contracts, corporate profits decline, unemployment rises, and credit for businesses and consumers becomes scarce. None of this is good news for stocks. Indeed, during the 11 recessions the US has endured since 1950, stocks have historically fallen an average of 15% a year.
This history may suggest that selling stocks before a recession arrives and buying them after it departs would be a smart strategy. But savvy investors know that it is extremely difficult to do this successfully and it’s often a recipe for locking in losses. A better idea may be to review your portfolio and consider diversifying with other investment opportunities that could help you stay on the path toward your long-term goals, recession or not.
Adam Kramer manages Fidelity® Multi-Asset Income Fund (FMSDX). He invests in a wide variety of income-oriented assets and seeks returns that are comparable to what stocks have historically delivered, but with much less volatility than stocks, which have historically struggled during recessions. Kramer says, "No matter where we are in the business cycle, it's always a good time to be a multi-asset income investor. I think of it as 'doing more with less.' That means 'doing more stock-like returns, with less stocks and less volatility.”
Unlike managers of strategies that can only invest in a few types of assets, even if those may not present the most attractive opportunities, Kramer looks for high-quality assets whose prices have been temporarily pushed down by investors overreacting to uncertainty about factors unrelated to the ability of the assets to deliver yield to the investor who holds them. Given widespread anxiety about where the economy may be headed, that means this may be an especially fruitful time to look for mispriced assets.
"Market conditions constantly change and the investments that deliver the highest returns today may not be the ones that do so next month or next year," says Kramer. "For a long time it was stocks, stocks, stocks. This year, though, I believe the best-performing asset class is likely to be something other than stocks. We're trying to find investments that have a recession already priced in,” he says. "There's always an opportunity no matter where we are in the business cycle. The flavors are always changing.”
Opportunities in investment-grade corporate bonds
“We've been gravitating to investment-grade bonds,” says Kramer, “because if inflation doesn’t slow down, a slow-down in the economy seems inevitable.”
History makes a strong case for these types of high-quality bonds in an economic downturn. In every recession since 1950, bonds have delivered higher returns than stocks and cash. That's partly because the Federal Reserve and other central banks have often cut interest rates in hopes of stimulating economic activity during a recession. Rate cuts typically cause bond yields to fall and bond prices to rise.
Kramer says that investment-grade bonds of high-quality companies can provide an alternative to owning those companies’ stocks in an economic environment where bond prices have historically risen and stock prices have fallen. Right now, the interest payments—known as coupons—on many investment-grade bonds are also higher than they have been in recent years. Those coupon payments, as well as their prices in the marketplace, contribute to the total return of these bonds.
Keep in mind, though, that the bond universe is a far more vast and variegated place than the stock market and not all bonds perform equally well during recessions.
Among the most attractive investment-grade bonds right now, according to Kramer, are those issued by utility companies, master limited partnerships that operate oil and gas infrastructure, and big US money-center banks. “Some of these fixed- and floating-rate subordinated bonds as of June 23, 2023, are paying current yields of 6% or 7%, are trading at 90 cents on the dollar, and will begin to float at more attractive yields in 1 to 3 years. A few years ago, you’d need to look to bonds issued by companies with much lower credit ratings to get those types of yields. Many of them are callable in 1 or 2 years so there's not much duration risk either. I think that there's been a lot of bad news priced into not only regional banks but also money-center banks and utilities.”
Opportunities in high-yield corporate bonds
While a potential economic slowdown might seem to raise risks that non-investment-grade bonds could default, Kramer says high-yield bonds are available that offer current yields in the high single digits without excessive risk. In a diversified portfolio, those high yields could potentially offset declines in asset prices that often accompany economic slowdowns.
Kramer explains that, "High-yield bond yields are now exceeding the rate of inflation and I feel like you're getting a bigger bang for your buck in high-yield than stocks of the same companies. If earnings decline, high-yield bond prices are likely to be less volatile than stock prices. High-yield is also attractive because more than 50% of the market is currently rated just below investment-grade and presents relatively little credit risk. It's unusual in a good way that there are no sectors of the high-yield market that have higher levels of risk right now. Even if the economy gets worse, you could still earn close to 10% on high-yield with much less volatility than stocks.”
Opportunities in longer-term Treasurys
Besides investment-grade corporate bonds, government bonds such as US Treasurys have historically delivered higher returns during recessions than stocks or high-yield corporate bonds. For months, uncertainty about the lifting of the US federal debt ceiling had raised questions about the Treasury market but a bipartisan agreement to suspend the debt ceiling has allayed those worries and Treasurys are once again considered among the safest investment options.
In addition to the safety that comes from being backed by the full faith and credit of the federal government, Treasurys with maturities of 5 to 10 years may also present an attractive opportunity for return from both their relatively high current coupon yields and from a potential rise in their prices when the economy turns down and takes interest rates with it. “I think the economy slows, inflation slows, and the Fed eventually cuts rates," says Kramer. "If that happens and you have 5-, 7-, or 10-year Treasurys, you’ll be able to collect not just a 3.75% or 4% coupon yield but also start making total return as the rates move lower and the prices of Treasurys in the market rise.
And a stock opportunity too
While stocks have historically underperformed during recessions, the stocks of companies that mine gold could provide an unexpected source of opportunities if economic growth and interest rates come down in the second half of the year.
Gold has long been popular with investors who are concerned about the power of inflation to reduce the value of cash and other investments, but owning it also comes with risks. Gold miners' earnings have historically grown when demand has risen, as it often has in times when economic growth has been weak and real yields decline along with interest rates. Gold miners typically distribute a significant portion of those earnings to shareholders in the form of dividends.
According to a study by McKinsey & Company, the gold-mining industry is also likely to experience a wave of mergers and acquisitions in coming years, which could further increase the appeal of mining company shares for investors.
Like other stocks, dividend-paying value stocks of gold-mining companies have been affected by higher interest rates, but Kramer believes that both rates and a potential economic slowdown have already been priced in and gold miners now offer sustainable dividend payments of 4% to 5% as well as attractive stock prices.
Not all that glitters is gold
Of course, just because an investment is unfamiliar doesn't mean you want to buy it and professional management and research can help you manage the risks that come from venturing into less-common income investments. Investors interested in multi-asset income strategies should research professionally managed mutual funds or separately managed accounts.
Copyright © Fidelity Investments
