While no one can predict the market, 80% of respondents to a Richardson GMP survey said they expect the next bear market to take hold within two years, including nearly 30% who said it would occur next year.
The survey highlights an important—and inevitable—market event for which investors must prepare.
“We do not want to be tilted toward cyclical yield in the next bear,” says Richardson GMP in a report. Cyclical yield, when it comes to dividend-focused equities, targets dividend-paying companies that are more sensitive to the economy than to changes in interest rates or yields. An example is package delivery service UPS.
Richardson GMP acknowledges that it’s impossible to call tops or bottoms for the market. Still, managing the turn from cyclical yield to interest rate sensitive investments will be a crucial determinant of future investing success, it says.
“If the bear market coincides with a recession, as is usually the case, being more sensitive to economic data will not be good,” says the firm, referring to cyclical yield.
Despite that concern, the firm says it appears “way too early” to make a move away from cyclicals.
In weekly market commentary, Richard Turnill, global chief investment strategist for BlackRock, agrees: “The rise in U.S. rates and flattening of the yield curve are stoking concerns about possible recession risks. We see these worries as premature.”
That’s because the increase in short-end rates reflects greater confidence in growth and inflation outlooks, he says. The increase “has largely run its course, in our view,” he adds, “as markets have priced in further Federal Reserve rate increases.”
As supporting evidence of further run for cyclicals, Richardson GMP notes that for both the S&P 500 and the TSX, the better performing sectors right now are those considered more levered to the economy—tech, industrials, materials and energy.
“We don’t believe this thematic has been played out,” says the firm, noting that the duration and magnitude of the outperformance of interest rate sensitives over cyclical yield lasted more than half a decade, up until mid-2016.
Plus, rising inflationary data such as the producer price index (PPI), wages and other metrics “could surprise the market in coming months to push yields higher,” says the firm—a situation that favours cyclical yield.
Turnill does a deep dive on the flattening yield curve to assess recession risk. One point he makes is that cyclicals have been outperforming defensive stocks as the yield curve has flattened—suggesting confidence in the expansion is still strong.
Richardson GMP says it will consider tilting away from cyclicals if yields move higher—for example, greater than 3.3% for the 10-year Treasury.
Another indicator would be a deterioration in the firm’s market cycle indicators, notably on the economic side.
“Weakness in these would cause us to become more conservative in our allocations to companies sensitive to the economy,” says the firm. “Currently, these indicators remain rather bullish for the market cycle.”