Manulife Investment Management strategists emphasize active management as economic indicators point to US recession fears
This article was produced in partnership with Manulife Investment Management
In August, Wall Street experienced its steepest decline in nearly two years, as fears of a slowing U.S. economy triggered a global selloff across financial markets. Stocks tumbled on one particularly volatile Friday, with the S&P 500 marking its first back-to-back loss of more than one percent since April. Canada's S&P/TSX Composite Index was not spared, falling 2.1 percent as major energy, technology, and industrial stocks suffered significant losses, marking its sharpest drop since mid-February.
This market upheaval has placed a spotlight on the reliability of economic indicators and the challenge of interpreting them in today’s complex environment. “The leading economic indicators have been negative for a long period without a recession,” notes Kevin Headland, Co-Chief Investment Strategist at Manulife Investment Management, in conversation with Wealth Professional.
The recession debate
However, Headland emphasizes that the key is not merely identifying whether a recession will occur but understanding the direction of economic trends. “We can't argue the direction, but perhaps we can argue the magnitude or the timing,” he adds. The clear signal from these indicators is a slowdown, which is crucial for guiding portfolio allocation.
Fellow Co-Chief Investment Strategist at Manulife Investment Management Macan Nia observes, “If you do believe that we are trending towards the end of an economic cycle, there's clear winners and losers from a profitability perspective.” Recent earnings reports have underscored this point, with companies that failed to meet optimistic earnings expectations facing significant market penalties.
“We’ve been telling clients the importance of active management at this point in the cycle,” Nia continues. He advises against overexposure to cyclical stocks, instead advocating for a focus on non-cyclical companies with high-quality earnings, which are more likely to meet market expectations. The stark performance contrast within the ‘Magnificent 7’ stocks exemplifies this, as investors realize that the monetization of these companies’ potential may take years, leading to short-term impacts on their valuations.
While the word ‘recession’ looms large, Headland argues that the focus should instead be on whether we are in a re-accelerating or slowing environment. “A recession may not be triggered, and I don't think we should wait until that word is announced to prepare our portfolios,” he notes.
The role of active management in a slowing economy
Headland warns against being overly optimistic or overly pessimistic, advocating instead for a balanced approach. “We should not be overweight equities right now to an extreme degree. It’s time to reassess portfolios and ensure we're not taking unintended risks.”
Over the past year, both Nia and Headland, have advised clients to increase their bond weighting within their portfolios, emphasizing the importance of high-quality sovereign bonds and investment-grade credit. This advice is particularly relevant now as yields have started to fall in response to the economic slowdown.
Given the potential volatility ahead, “It’s a good time to trim those winners,” Headland suggests, noting that while certain companies have driven recent market gains, the time may be right to lock in profits and reduce exposure to areas with inflated expectations.
At some point, the market will have to adjust to the reality that bad news is indeed bad news, and this could trigger some volatility. However, this correction could also present a buying opportunity, marking the bottom before the next phase of economic expansion. While short-term volatility may be unsettling, the Chief Investment Strategists find it could also be beneficial by bringing down valuations, which is key when considering market expectations and profits over a 5 to 10-year horizon. This relationship between market performance and long-term profit expectations remains one of the strongest indicators.
“The strength of the US consumer has been a major factor in delaying the slowdown,” Nia observes, adding that cracks are beginning to show in consumer health.
The election factor: headline risk or economic reality?
Elections, particularly in the United States, are often viewed as critical events that could sway markets. However, Headland says, “We've done a lot of work on US elections going back to 1950. Ultimately, it doesn't really matter on long-term averages.” While specific policies, such as tariffs or anti-trade legislation, can impact certain companies, the broader market typically weathers the changes with little long-term effect.
Headland emphasizes the importance of diversification during election cycles. “It's about looking under the hood at specific companies and understanding the risks and opportunities that might arise from policy changes,” he advises. Diversifying across sectors and capitalization sizes can help mitigate the choppiness often associated with election headlines.
Nia adds that the biggest risk during election periods is often investor behaviour, not the election results themselves. He cites the 2016 US election as an example, where many investors reacted emotionally to headlines, potentially missing out on significant market gains. “If you had acted on emotion, you would have missed out on the second half of the longest bull market in US history,” Nia warns.
Moving forward
The post-pandemic world presents a far more complex scenario. The pandemic did change things, Headland notes, pointing to the massive liquidity injections, demographic shifts, and evolving job markets that have added layers of complexity to economic analysis.
Traditional indicators, once reliable, now appear skewed or delayed. The inverted yield curve, for example, has remained inverted for an unprecedented duration, leading some to question its continued relevance. “People say it's broken,” Headland observes, but the real focus should be on the direction of the economy, not just the timing of a potential recession. The smooth ride that equity markets have enjoyed in recent years may have lulled some into forgetting that volatility is a normal part of investing. Typically, markets experience two 5% pullbacks annually and a correction every few years—this is the norm, not the exception. As the global economy continues to slow, short-term market vulnerabilities are likely to increase.
For investors, the key to meeting long-term financial goals, such as retirement, is to look past the daily headlines and stay focused on the bigger picture. Nia advises, “You should be checking your statements as much as you go to the dentist—twice a year.” This approach helps avoid getting caught up in the emotional and irrational reactions that can arise during market fluctuations.
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