Strategic Sector Selector - Cloudy with a chance of recession

The slump in global equities deepened in the second quarter of 2022 as concerns about a recession replaced fears of high inflation and an escalation of the war in Ukraine seemed less likely. The US Federal Reserve has maintained its hawkish stance despite the increasing threat of a significant slowdown in economic growth. We think the probability of our downside tail risk scenario has increased and therefore we shift into a more defensive allocation. We change our exposure to cyclicals to Neutral by downgrading both late-cyclicals, such as basic resources and industrial goods & services, and early-cyclicals including retailers, travel & leisure and financial services. In turn, we raise consumer staples to Overweight and telecommunications to Neutral. Finally, we upgrade real estate where high yields could provide some stability, in our view, and media, which we find more attractive after significant underperformance.
Changes in allocations:
- Upgrades: media, food, beverage & tobacco, personal care, drug & grocery stores, real estate (N to OW), telecommunications (UW to N)
- Downgrades: basic resources, industrial goods & services, retailers (OW to N), travel & leisure, financial services (OW to UW)
Most favoured | Least favoured | |
Sector | US healthcare | European travel & leisure |
EM technology | European energy |
Sectors where we expect the best returns:
- Healthcare: exposure to moderating rate expectations, defensive sector, strong pricing power
- Real estate: high yield, attractive relative valuations, decent dividend growth prospects
- Technology: resilient demand for products and services, high margins, exposure to growth factor

Notes: On the horizontal axis, we show how far a sector’s valuation is above/below that implied by our multiple regression model (dividend yield relative to market). The vertical axis shows the perpetual real growth in dividends required to justify current prices relative to that implied for the market. We consider the sectors in the top right quadrant expensive on both measures, and those in the bottom left are considered cheap. See appendices for methodology and disclaimers. Source: Refinitiv Datastream and Invesco