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Market Outlook

Diversify Recession Risks with Cyclicals and Defensives

2023 Midyear ETF Market Outlook

The threat of recession has loomed over investors for more than a year, ignited by the inversion of the yield curve, which typically predates a recession by six to 24 months.1 That relationship has held since 1955, with just one false signal over a nearly 70-year period.

After first inverting in April 2022, the yield curve has been persistently inverted since July. That puts us roughly in the middle of the recession window. So, will the “yield curve as predictor of recession” relationship hold?

If you’re an optimist, you might believe the economy will face only a protracted slowdown, buoyed by the resilient consumer and a strong jobs market. But pessimists are more likely to brace for recession, pointing to multiple leading economic indicators skewed to the downside.

These divergent viewpoints and potential outcomes make portfolio diversification even more vital now. To pursue current cyclical opportunities without giving up potential downturn protection, consider a mix of the following:

  • Cyclical industries, especially the consumer-centric Homebuilders and Transportation
  • Gold, whether growth only slows or a technical recession occurs
  • Non-cyclical stocks, to combat volatility and position for recession

To better understand the dual-nature of this economic backdrop, let’s dive a little deeper.

Leading Indicators Signal Recession Risks

Among the many indicators pointing to economic weakness, readings on year-over-year (YoY) changes of the Conference Board US Leading Ten Economic Indicators Index (LEI) have been negative and declining for the past nine months.

LEI Year-Over-Year Change % Stokes Recessionary Fears

LEI Year-Over-Year Change % Stokes Recessionary Fears

Negative readings have coincided with every US recession except in 1960. Only the recessions of 1975 and 2009 were preceded by more consecutive months of negative YoY changes.2

So, while the LEI’s current change of -7.8% is not as weak as historical cycles (all recessions except for 1970 had deeper declines), the duration of negative readings is significant. Also backing the view that recession is coming, 75% of the indicators that make up the LEI are in decline right now.3

But not everything is in decline.

Strong Labor Boosts Consumer Spending, Outlook for Cyclicals

The labor market remains strong, with the employment-population ratio for those aged 25-54 rising to 80.8% — its highest level since 2001.4 And while tech and banking have had layoffs, other industries are increasing pay to attract workers. In fact, average hourly earnings are up 4.4% from a year ago.5

Unlike the lack of breadth in the economy, job growth is broad-based. Despite some softening, the Bureau of Labor Statistics' diffusion index still sits above 50,6 underscoring the resilience of labor demand amid elevated interest rates and sluggish macro trends.

Higher wages have increased disposable incomes. Inflation-adjusted disposable income, the main support for consumer activity, increased 0.3% recently.7 This pushed the savings rate to 5.1%, the highest since the end of 2021, indicating healthy consumer balance sheets.8 And credit card delinquencies are still below average, despite record credit card debt.9

These gains in labor and wages are supporting consumer spending — the largest portion of economy — and keeping growth positive. In the Q1 GDP report, the consumer was the main driver of growth, expanding by 3.7% compared to the 1.1% headline figure.10

In fact, inflation-adjusted final sales to private domestic purchasers, a key gauge of underlying demand, rose 3.2% on the quarter, the most since Q2 2021.11 Forward-looking consumer sentiment indicators have been improving as well, climbing off the bottom from mid-2022.12

Homebuilders Benefits from Stable Earnings, Constructive Valuations

With Homebuilders reporting better-than-anticipated new home sales and higher traffic of prospective buyers, the National Association of Home Builders (NAHB) Confidence Index has climbed every month this year.13

A slight decline in mortgage rates from the cyclical peak in 202214 has also contributed to improved confidence. And if the Fed does lower policy rates, mortgage rates that are still elevated relative to historical averages could fall further.15

The earnings outlook for Homebuilders has stabilized against this backdrop. The number of earnings downgrades decreased heading into the spring and remains at its lowest level in a year.16 Thanks to easing supply chain pressures and disinflationary trends in goods, prices of building materials have declined on an year-over-year basis for three straight months to the level of April 2021.17

With that tailwind, Homebuilders reported strong Q1 2023 earnings (25% above estimate versus the 6% for the S&P 500 Index) and sales surprises (8% above estimates versus 3% for S&P 500 Index).18 Importantly, this recent strength hasn’t extended valuations.

After falling by 30% in 2022, the industry still has plenty of room to make up. Both on a price-to-earnings (P/E) and price-to-book (P/B) basis, Homebuilders is trading at a larger than normal discount to the S&P 500 Index, as shown in the following chart.19

Overall, housing supply remains tight while demand remains strong — boosted by the strong labor markets and healthy household balance sheets. Alongside improving earnings trends and constructive valuations, this may lead to a more optimistic outlook for this consumer-oriented industry.

Transportation on the Move

Transportation stocks may also benefit from a better-than-expected economic outlook and healthy consumer balance sheets. The S&P Transportation Select Industry Index has exposure to cargo and shipping markets — areas that could gain from supportive aggregate demand.

Transports also have nearly 40% allocated to passenger travel industries, and passenger travel data continues to improve. Recent global total traffic has risen 56% from one year ago to reach 85% of 2019 levels, according to the International Air Transport Association. In the US, traffic has recovered to 97% of 2019 levels.20

With the rebound in traffic, the transportation industry is expected to be profitable once again after dealing with the pandemic-related headwinds21 that kept it down over 28% in 2022.22 The poor prior year returns, however, have led to constructive valuations today.

On a price-to-book basis the transportation industry trades at a 48% discount to the S&P 500 Index compared to a historical average of 33%.23 The current P/B for the industry is also below its historical averages, 2.03 versus 2.31.24 Continued consumer strength and better-than-expected aggregate demand could further benefit this cyclical sector.

Macro Risks and Partisan Conflict Heat Up

The rate hike-pause-pivot pendulum continues to swing as the Fed works to engineer a soft landing and subdue stubborn inflation. With that uncertainty, key data releases will continue to have an outsized impact on sentiment and volatility, as investors try to predict Fed policy.

Fiscal policy won’t be any easier to forecast. Partisan conflict measures are above average25 and the lack of bi-partisan fiscal coordination (the Republican spending package passed by a razor-thin margin of 217-215)26 is likely to increase during the 2024 US election cycle.

The debt ceiling debate offers the starkest example of the current fiscal policy malaise. Here, familiar inertia or missteps will further strain the economy and could complicate future Fed policy decisions.

As Growth Slows and Risks Build, Think Gold

If macro risks slow economic growth, recessionary risks come into sharper focus. As a result, gold may benefit as investors position for the slowdown and pivot toward non-cyclical and defensive portfolio exposures to mitigate the downstream impacts of a recession.

Since 1971, when gold began freely trading in the post-Bretton Woods era, the US has experienced seven economic recessions. During these periods, gold averaged a 20.19% return, which led the way compared with other major US assets — including US stocks, Treasury bonds, corporate bonds, and the US dollar.

Additionally, gold managed to provide positive returns and outperform broad commodities in all but one of those periods (1990-1991), as shown in the following chart.

Gold Shines During US Recessions


Cumulative Performance During US Economic Recessions









Average Return










US Equities









US Corporates









US Treasurys









US Dollar


















Source: Bloomberg Finance L.P., National Bureau of Economic Research (NBER), State Street Global Advisors. Past performance is not a reliable indicator of future performance. Data from 01/01/1973 to 05/10/2023. Gold: LBMA Gold Price PM USD, US Equities: S&P 500 Index, US Corporate: Bloomberg US Corporate Bond Index, US Treasury: Bloomberg US Treasury Index, US Dollar: US Dollar Spot Price Index, Commodities: S&P GSCI Total Return Index. Recession periods measured from 1973-1975: 11/01/1973 – 03/31/1975, 1980= 01/01/1980 – 07/31/1980, 1981-1982 = 07/01/1981 – 11/30/1982, 1990-1991 = 07/02/1980 – 03/29/1991, 2001 = 03/01/2001 – 11/30/2001, 2007-2009 = 12/03/2007 – 06/30/2009, 2020 = 02/03/2020 – 06/30/2020 . Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable.

Look to Low Volatility Stocks Amid Higher Risks

Similarly, if volatility increases as a result of increased macro risks coinciding with economic strain, defensive equities may offer support. Investing in low volatility strategies enables investors to stay invested in equities, but with less systematic risk.

In down markets, low volatility stocks can temper the impact of losses on portfolios. Over the past 30 years, in months when the market falls, low volatility stocks have felt just 67% of the downside — outperforming broad beta exposures by an average of 1.29%.

And with an upside capture of 80%, low volatility stocks also have participated in some of the market’s upside. In fact, in months when the market gained, low volatility stocks trailed their benchmarks by just -0.73%, on average.27

With a historical upside-downside capture ratio of 1.2 (80%/67%), low volatility stocks can help portfolios navigate choppy markets.28

Implementation Ideas

Blend cyclical and non-cyclical exposures to diversify recession outcomes, and consider:




Defensive Equities


Bio Image of Michael W Arone

Michael W Arone, CFA

Chief Investment Strategist

Bio Image of Matthew J Bartolini

Matthew J Bartolini, CFA, CAIA

Head of SPDR Americas Research


Bio Image of Anqi Dong

Anqi Dong, CFA, CAIA

Senior Research Strategist

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