As the new year begins, investors and economists are shifting their focus toward what’s to come in 2024.
Going into 2023 there were almost unanimous predictions that the US economy would experience some form of recession. There was a good reason for that. Historically, when interest rates rise quickly to combat high inflation, economic contraction is soon to follow.
That didn’t happen this time, though. A recession — defined as at least two consecutive quarters of negative gross domestic product (GDP) growth — never materialized in 2023.
That might come as a surprise to many Americans, who have been hit with high prices and mass layoffs across a wide variety of industries. Amazon, Google, Disney, Gap, Goldman Sachs, Nike and many more companies, big and small, cut thousands of jobs in 2023.
The question now, of course, is what will the new year hold? Forecasts are a lot more mixed, perhaps because almost everyone got it wrong in 2023. Many economists, including those at Bank of America’s Global Research division, are predicting a so-called “soft landing.”
There’s no official definition of what constitutes a soft landing, but it’s generally agreed to have happened when central banks like the Federal Reserve are able to respond to economic slowdown by lowering interest rates in time to cause only a mild recession, or none at all.
If there is a soft landing, we can expect to start seeing the economy enter a growth phase soon afterward. Over the last year, most investors based their strategy on the playbook for a recession — but what about when the economic outlook is positive?
Here are three investments experts recommend during an economic upturn.
Small-Cap Stocks
Cap, short for market capitalization, is the total market value of a publicly traded company. While the precise definition can vary, a company with a market value of $250 million to $2 billion is generally considered to be a small-cap stock.
Robert R. Johnson, PhD, Certified Financial Analyst (CFA) and Professor of Finance at Creighton University’s Heider College of Business, thinks small-cap stocks are a wise choice during an upturn, and has the data to back it up.
“Economic upturns are often referred to as ‘risk on’ environments, meaning that riskier assets tend to perform better than less risky assets,” he said.
“In ‘Invest with the Fed,’ my co-authors and I found that from 1966 through 2020… small stocks outperformed large stocks during a falling rate environment. With the positive economic outlook for 2024 and the expectation that the Fed will lower interest rates over the course of the year… specifically, investors may want to consider small cap market index funds — like those mirroring the Russell 2000,” Johnson continued.
High-Yield Bonds
Bonds are debt instruments that companies issue to raise capital that investors can buy and sell much like stocks.
Companies issuing bonds are typically assigned a credit quality rating by rating agencies like Moody’s and Standard & Poor’s which indicates how likely they are to default on their debt. The bonds of companies with strong ratings are referred to as investment-grade, while those from companies with weak ratings are called speculative-grade — more commonly known as junk bonds.
As the name implies, junk bonds can be risky, but they also offer much higher interest rates to attract investors.
“When the economic outlook is good, that can be a great time to invest in high-yield bonds,” said David Kemmerer, the CEO of CoinLedger.
“High-yield bonds are typically high-risk investments to avoid during times of recession and economic volatility, because they are highly susceptible to downturns in the market. So, if the economic outlook is positive, the risk decreases for these types of investments while the potential for high returns increases.”
Dividend Stocks
For more conservative investors, small-cap stocks and junk bonds may be too risky. That doesn’t mean they can’t also take advantage of an economic upturn.
Christopher Sargent, portfolio manager and research analyst at investment management firm Bradley, Foster & Sargent, said that high-quality mega cap stocks that have a great credit rating and pay a dividend are also a good strategy.
“Look for major trends such as AI and onshoring that give industries like tech and manufacturing a strong outlook,” said Sargent.
“If a company has a particularly high barrier to entry, or an asset that can’t easily be replicated by a competitor, that lowers its risk profile. Even if rail freight has a difficult year, a competitor isn’t likely to build a new railroad anytime soon, so you can count on a degree of stability.”
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