The twin evils of inflation and economic slowdown demand a smarter strategy than just holding the sector with the highest positive sensitivity to inflation (i.e. energy). In this paper, we consider how sectors react in difficult economic and inflationary periods. Given the risk aversion in equity markets, we also consider the volatility of each sector.
Energy and health care still look relatively attractive given the key macroeconomic drivers, shifting investor sentiment, and divergent earnings sentiment. How do they look in a barbell strategy?
High dispersion of returns between sectors continues to offer an opportunity to investors, especially those investors seeking to play the economic outlook.
The simple strategy of holding just one sector has been remarkably profitable, particularly in the case of our key SPDR Sector Pick for the past 12 months, energy. Not only has world energy generated an absolute return of 60%, but this is 80% ahead of the worst performing sector, communication services. Health care, our favoured defensive sector, has also outperformed, and a combination of health care and energy would have offered a rewarding, relatively low-risk alternative.1
A barbell strategy can provide diversification of risk, helping investors to take advantage of differences in sector characteristics. Do these sectors still work in an environment of high inflation combined with a contracting economy (stagflation)? What about alternative combinations?
This analysis looks at the performance of the 11 GICS sectors relative to the S&P 500 and MSCI Europe indices during regimes of high and low inflation and positive and negative economic growth. We conclude with three barbell combinations to see which has best weathered past stagflation regimes, while also ensuring that the performance and risk is acceptable across other regimes.
1 Source: Bloomberg Finance L.P., as of 8 June 2022.
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