Preparing your portfolio for an economic slowdown in 2024

FOR much of 2023, investors, consumers, and central bankers alike were watching for a recession. Instead, the US economy kept growing, and the job market remained healthy.

Now the big question remains: Will a recession arrive in 2024, or can the US Federal Reserve achieve a “soft landing” by keeping interest rates just high enough to slow inflation without crashing the economy?

We believe that regardless of whether you think a downturn is imminent or not, there will always be pockets of opportunity in the market.

An example is high-quality assets. Their prices have been temporarily pushed down by investors overreacting to market noise or short-term uncertainties, which are often unrelated to fundamentals or the asset’s ability to consistently deliver yield.

Given the uncertainty about where interest rates and the economy may be headed, this may be an especially useful approach for income-seeking investors to take in 2024.

Doing more with less

Opportunities in 2024 could exist in investment-grade bonds, which include Treasury bonds and investment-grade corporate bonds. Since the Fed began raising interest rates in 2022, yields of these have risen to attractive levels.

For example, a fixed-income investor looking to build a portfolio with healthy yields would have needed to allocate a vast majority of the portfolio to high-yield bonds in the years running into the recent interest-rate hike cycle. At present, one would be able to achieve this with the vast majority, if not all, of the allocation to investment-grade bonds. Hence, one can now achieve attractive level of yields without taking on excessive credit risk.

Within Treasury bonds, the opportunity lies in bonds with medium- to long-term maturities. Bonds issued by the US Treasury offer low default risk and liquidity, which can potentially be a rare and attractive opportunity for investors who can take advantage of it.

The longer-maturity Treasuries offer a rare opportunity to “do more with less”. If interest rates remain “higher for longer”, these bonds’ relatively high coupon payments may offset the risk that higher interest rates could pose to bond prices. On the other hand, if the economy takes a downturn, they can also offer a downside buffer and could potentially generate significant returns as rates tend to move lower in an economic downturn.

Investors seeking yield, liquidity, low default risk of Treasuries with the potential for rising prices when rates fall in the future, may find this a good time to enter at current attractive prices.

While Treasuries may present a unique opportunity as 2024 begins, there are other income assets that may deliver higher returns with less potential volatility than stocks in the year ahead, especially if the economy does slow down.

Another group of assets that could offer attractive returns in 2024 are bonds issued by companies whose credit ratings are investment-grade.

Investment-grade bonds issued by these companies can provide an attractive alternative to owning their stocks, as they tend to be more resilient in a recession or in economic slowdowns. In past recessions, these bonds have typically outperformed their companies’ stocks. Right now, as the yields on many investment-grade bonds have risen, the difference between yields on these bonds and dividend yields of the companies’ stocks are close to multi-period highs.

The default risk of companies rated investment-grade has historically been very low, and thus could potentially offer more attractive opportunities than riskier high yield corporate bonds in an economic slowdown.

Keep in mind, though, that the bond universe is vaster and far more diverse than the stock market, and not all bonds perform equally well during recessions. Hence, careful research is key.

The fact is, fretting over when the next recession may arrive is not a recipe for successful investing, as it is proven that time in the market is much more important than timing the market. It is much more important to put together a diverse portfolio of income-producing assets that is resilient if things go badly and also do well if they don’t.

Regardless of what phase of the business cycle the economy may be in, there are nearly always opportunities to buy mispriced assets that seek to help deliver income for investors and also have the potential to increase in price over time.

The writer is client portfolio strategist at Fidelity International