Authored by Simon White, Bloomberg macro strategist,
The US retail sector will be an effective portfolio hedge for a recession.
We got a check in on how the consumer is doing on Friday with March’s retail sales data. Emblematic of the weakening economic backdrop, consumers’ retail spending is falling sharply from the surge it saw as pandemic restrictions were eased.
Leading data anticipate that this sharp fall will continue. In the short term, higher-frequency data, such as the weekly Redbook index, points to a weaker retail-sales print today.
Longer term - over the rest of this year and into next - discretionary spending will continue to suffer as essential costs, such as energy and mortgages, keep rising. The sharp fall in homebuyer affordability is a bad omen for retail sales.
Furthermore, even though the retail sector has worked inventories lower from the glut incurred after Covid, sales-to-inventory levels are barely back to pre-pandemic levels, while a recession would knock them lower again.
The US economy is beginning to look very recessionary, with some signs that one could already be here, or very close to starting.
That would, historically, lead to a further decline in equities. That may end up happening, but this is an odd cycle. At least one rare and reliable technical signal for the S&P recently triggered, telling us that price action is pointing to a constructive picture for stocks over the longer term.
Therefore shorting the overall index or even buying downside protection may not be the most efficient way to hedge for a recession.
However, retail is primed to be one of the most underperforming sectors in any recession.
Firstly, it is highly cyclical. Indeed, currently, it is the most cyclical of the GICS Level 2 sectors, based on variability of earnings. Cyclical stocks underperform in downturns.
Secondly, looking at past recessions, the retail sector has on average fallen by the most in the six months after a recession starts.
Retail has only slightly underperformed the index this year, but if the runes are correct and a recession is almost upon us, this underperformance will intensify.
The semis sector should also see significant underperformance in a recession, with the added benefit it has also outperformed more than most sectors this year.