Bank of America Merrill Lynch (NYSE: BAC) has joined a growing list of prominent voices on Wall Street warning that the U.S. economy is in the late cycle stage, or the phase just before the economy slides into recession.
The note, titled “U.S. Economy bull/bear: Most signs point to late cycle,” was sent to clients late last week and said that the bank’s analysts found that 15 of the 25 different major sectors the firm follows indicate that the economy is in the late cycle, which is in line with its economists’ and strategists’ views as well.
“Putting the pieces of the puzzle together, we see an economy that is set to slow into the end of next year as fiscal stimulus fades and the Fed brings interest rates higher,” Michelle Meyer, U.S. economist for the firm, wrote in the note. “We will need to recalibrate from a 3 percent economy back to a low-2 percent economy, as has been typical throughout this expansion.”
While Bank of America’s forecast calls for a recession starting in 2020, JPMorgan (NYSE: JPM) Asset Management’s Ben Mandel warns that a slowdown in global growth could sink the U.S. into a recession in 2019.
“What’s happening right now is a little bit of difficulty discerning between what is a late cycle slowdown and what is the end of the cycle,” Mandel said to CNBC on Tuesday. “The U.S. sort of coming back to Earth after an exceptional period of growth and then no one really picking up the slack.”
“We went from a story of synchronized global growth in 2017 to one in which there was U.S. growth leadership in 2018,” he said. “At the beginning part of 2019, it’s looking to become more synchronized again, but not in a good way.”
According to Mandel, JPMorgan’s strategy reflects the current market risks.
“We’re now underweight slightly equities versus bonds in our portfolios,” he said. “We brought cash up from neutral to a slight overweight in our portfolios. You know you have a small return that’s positive there, and again, a hedge for a lot of those late-cycle shocks – including inflation and policy.”
Bank of America believes the S&P 500 will peak around 3,000 this year, saying, “Our team still sees upside to equities, owing mostly to still-supportive fundamentals and more reasonable valuations, but believes this year will likely market the peak.”
With that, the firm says that high-quality, low-risk and large cap stocks will be the best place to be in this phase. However, there are a few sectors investors may want to steer clear of in this environment.
“In addition to higher input costs from tariffs, we also see labor costs as a risk to labor intensive sectors’ margins,” wrote Bank of America’s chief U.S. equity and quant strategist, Savita Subramanian. “Consumer Discretionary, Industrials, and Consumer Staples are the most labor-intensive sectors (highest employee/sales ratios), where we see risk to Discretionary margins in particular which have been driven up amid years of cost cutting.” Adding that, “Companies with pricing power should fare best.”
Bank of America also noted the chance that we are already in a bear market as 10 out of its 19 bear market signposts currently are flashing red. Their indicators include interest rates, trailing return, rising volatility, and consumer confidence readings.
If we are already in a bear market, or when we enter one, the firm says health care and consumer staples stocks will likely perform well. They also say that, despite their historical bear market track records, bank and technology stocks could hold up well this time around.