Janus Henderson: Cut Stock Exposure as Recession Looms

As the economic landscape continues to shift, investors are increasingly concerned about the potential for a recession. Janus Henderson, a leading global asset management firm, has issued a warning to investors, advising them to cut down their exposure to stocks as the risk of a recession looms. The firm's analysis is based on a variety of indicators, including the yield curve, the Conference Board's index of leading indicators (CBLI), and macroeconomic and financial uncertainty.

The yield curve, specifically the spread of the 10-year Treasury bond rate over the three-month Treasury bill rate (10Y3M), is a commonly used indicator. Historically, an inverted yield curve, where long-term bond yields are lower than short-term yields, has been a reliable predictor of recessions. For instance, prior to a recession, interest rate spreads become negative, and the CBLI declines. This indicates that these indicators have shown some reliability in predicting recessions.

However, it is noted that "we also occasionally have negative spreads and declining CBLIs that are not followed immediately by recessions," indicating that while these indicators are useful, they are not foolproof. Macroeconomic and financial uncertainty are also highlighted as significant predictors of recessions. In-sample forecasts using probit models indicate that these variables are the best predictors of recessions at short horizons. Macroeconomic uncertainty has the highest predictive power up to 7 months ahead and becomes the second best predictor after the yield curve slope at longer horizons. This suggests that these indicators have historical reliability in predicting recessions, especially in the short term.

Given the potential for a recession, Janus Henderson suggests several strategies for investors to reallocate their portfolios to mitigate the risks associated with a potential recession. One key strategy is to use direct indexing, which provides access to a wide range of exposures, including the S&P 500 or Russell 3000 Index. This approach can help diversify a concentrated stock position by placing stock, industry, or sector level restrictions on the account to reduce duplicative exposure. Direct indexing can also help reduce the tax burden by generating losses that can offset gains realized when reducing the concentration. Additionally, a customized staged diversification plan can spread the cost of diversification over several years, allowing for greater control of the tax bill and the degree of diversification. This plan can be modified at any time depending on changes in the market or client needs.

Another strategy suggested by Janus Henderson is the use of exchange funds. Instead of selling a concentrated position, investors can contribute it to an exchange fund and swap it for an ownership share of the fund’s diversified portfolio of equities and qualified assets. This allows for tax-free diversification over the holding period of the exchange fund, typically a minimum of seven years, although the gains are simply deferred, not eliminated.

Covered call writing is another strategy recommended for investors who want or need to hold their concentrated shares. A customized program can seek to enhance total return and lower volatility. This rules-based strategy may also focus on mitigating the number of shares sold and maintaining as much upside potential as possible.

In terms of safer alternatives to stocks, Janus Henderson does not explicitly mention specific asset classes or sectors. However, the strategies suggested, such as direct indexing and exchange funds, imply a focus on diversification and reducing concentration risk, which are generally considered safer approaches during economic uncertainty. Additionally, the use of covered call writing suggests a strategy that can provide downside protection while still allowing for some upside potential, which can be beneficial during a recession.

In conclusion, as the risk of a recession looms, investors should consider cutting down their exposure to stocks and reallocating their portfolios to mitigate the risks associated with a potential recession. Janus Henderson's analysis and suggested strategies provide a roadmap for investors to navigate the uncertain economic landscape and protect their portfolios from potential downturns. By focusing on diversification and reducing concentration risk, investors can position themselves for success in a variety of economic scenarios.