As worries about a U.S. recession rise, risk-averse investors who seek to limit their downside should consider recent recommendations by Sophie Huynh, a cross asset strategist at Societe Generale. She expects the U.S. to be in recession by 2Q 2020, and recommends three ways that investors can reap sizable profits in spite of the downturn, per a report in Business Insider.

These three strategies are: buy U.S. stocks that have a history of strong dividend growth, short the Nasdaq 100 Index while buying emerging market stocks, and tilt your U.S. stock holdings toward the large cap S&P 500 while reducing exposure to the small cap Russell 2000. Meanwhile, a growing number of leading investment managers around the world are turning defensive, according to Bank of America Merrill Lynch, but that firm's strategists believes that the fears are overblown.

Key Takeawsys

  • Societe Generale strategist expects a mild U.S. recession by 2Q 2020.
  • She has 3 recommendations for investors.
  • Buy U.S. stocks with high and rising dividends.
  • Short big tech stocks, buy emerging market stocks instead.
  • Favor large cap over small cap U.S. stocks, to limit debt-related risk.

Significance for Investors

Huynh has found that U.S. stocks usually outperform non-U.S. stocks for more than a year after the Federal Reserve starts a cycle of interest rate cuts. Moreover, she anticipates that the downside for U.S. stocks will be limited by the Fed's program of interest rate reductions, especially the case with stocks that pay generous and growing dividends. Additionally, she predicts that the next recession will be relatively mild, limiting the damage that it inflicts on stock prices.

Another positive for dividend-paying U.S. stocks is that they offer higher yields, on average, than U.S. Treasury bonds. This should help to support stock valuations, Huynh says. The 10-Year U.S. Treasury Note currently yields about 1.8%, whereas the S&P 500 Index yields about 1.9%.

However, several S&P 500 sectors offer significantly better yields. These are energy, 3.5%, real estate, 3.2%, utilities, 3.1%, consumer staples, 2.9%, communication services, 2.3%, and financials, 2.1%, per S&P data cited by Yardeni Research. The overall S&P 500 average yield is brought down, in large part, by information technology, whose 1.4% yield is the second-lowest.

Moreover, Huynh expects that big tech stocks will face increasing headwinds to profit growth from rising regulatory and political scrutiny, as well as unfavorable new tax rules. Her bearishness on big tech leads her to recommend shorting the tech-heavy Nasdaq 100 Index, in which just the five FAANG stocks collectively account for about 35% of its value, while being market laggards over the past year.

Investors are getting increasingly nervous about highly-leveraged companies with low-rated debt, and these firms are more common in the Russell 2000 than in the S&P 500, Huynh notes. "Doubts about the effect of central bank easing on the real economy and/or fears of illiquidity have triggered more differentiation within risky assets," she told BI.

Looking Ahead

Choosing stocks simply on the basis of dividend yield has a large potential pitfall. Offering a persistently high yield may be the result of subpar price appreciation. For example, for the year-to-date through the end of August, the S&P 500 generated a total return, dividends included, of 18.3%, while a leading ETF focusing on high dividend yield stocks returned only 12.1%, Barron's notes.

Value stocks, which typically offer above-average yields, have outperformed in more recent weeks. However, a dividend-focused strategy may underperform if this rotation reverses again, Barron's warns.