No Banana Peel, No Recession, Strategist Says

After a historically quick spike in rates from the Fed, the inflation that followed and a big pile of evidence that has stoked past recessions, why haven’t the economy and the stock market broken down yet? 

David Kelly, JPMorgan Asset Management’s chief global strategist, may win the award for “best metaphor for 2023’s market.” On Tuesday, he recently expressed his view that a recession was not likely, but acknowledged the existence of many lower probability/major impact risks that could quickly change that.

In his view, we won’t have a recession unless the economy slips on a banana peel, a reference to the presence of many “by the book” indicators that have led many strategists to conclude the U.S. is headed for a recession.

For example, The Conference Board Leading Economic Index fell for a record 13th month in row in May. Then there’s the so-called inversion of the “10-2 spread,” the difference in yield between 10-year and two-year U.S. Treasuries (the “10-2 spread”).

That is when the yield on two-year bonds exceeds that of 10-year bonds, a rare condition that has been a very accurate recession forecaster. The 10-2 spread is approaching the one-year anniversary of its last significant inversion, which occurred in early July 2022.

It is a long way from returning to its natural state, as the spread currently stands around -0.80%, thanks in large part to the surge in yields on shorter-term Treasuries.

The challenge for exchange-traded fund investors if we tip over … or crash … into recession is how to capitalize on it. I toured the etf.com's ETF Finder with the intent of identifying ETFs classified as “Alternatives,” and found 41. Here are some to consider researching in the quest to find recession-resistant qualities, without slipping on the proverbial banana peel. 

The First Trust Long/Short Equity ETF (FTLS) has been around for nearly a decade, but seems to have found its stride, and its audience, in recent years. This fund is essentially a liquid version of a long/short hedge fund, buying and shorting stocks in roughly a 2-to-1 ratio.

The key in recessionary markets is whether the ETF’s methodology can perform well enough on both sides of that coin to keep losses moderate, or post a profit. FTLS has delivered a steady 27% total return over the past 36 months, while its assets under management have grown by about 145% to $678 million, implying that the market’s rough ride has prompted more investors to take a long/short approach within an ETF wrapper. 

The AGF US Market Neutral Anti-Beta Fund (BTAL) is also a long/short ETF, but its approach zeroes on a stock’s beta. This $364 million fund allocates equal amounts in buying stocks with low beta (volatility versus the broad stock market) and shorting stocks with high beta. That takes most of the market’s movement out of the equation, allowing BTAL to be competitive when the stock market favors relative safety, such as in recessions.

Recessions are typically determined officially well after they have started. We could be in one right now. Or, we might skip it altogether.

More important than the label attached to an uncertain economy is the decisions financial advisors and investors make in positioning themselves for whatever modern markets throw at them. Or, in the case of a banana peel, under them.