While the pending recession will be “relatively mild”, offset by a strong consumer balance sheet, Guggenheim Partners said investors should prepare for the S&P 500 to reset significantly lower.

“We believe that no one should be betting on the Federal Reserve pivoting from that in a quarter or two just because the United States is close to a recession,” Anne Walsh, chief investment officer at Guggenheim Partners, said in a note.

A recession could come as early as the middle of the year, but corporate credit fundamentals are strong heading into the downturn,” Walsh said.

Based on analysis conducted by Guggenheim’s research team of price-to-earnings multiples during times of slowing economic activity, the S&P 500 could trough as low as 3000 to 3200 during the forecast recessionary period, Walsh said.

The S&P 500 was trading near 4120 at about 1.15pm on Wednesday in New York; it has risen about 15 per cent from its October lows, including 8 per cent so far this year.

“Our view is that along with the fall in equities prices, the lowest rated credit end of the markets, like CCC-rated bonds, will also come under price pressure, likely selling off as defaults rise and downgrade activity increases,” Walsh also said.

As for bonds, Walsh said the transition from quantitative easing to quantitative tightening – from the US central bank buying assets to selling them –“spells trouble for risk assets”.

In addition, “a looming turn in the business cycle means the rates market should be a tailwind for fixed-income investors as 10-year Treasury yields head back down towards 3 per cent”.

The US 10-year note was yielding 3.80 per cent at 1.22pm (3.22am AEDT) in New York; the yield has risen 29 basis points in the last month as mostly better-than-expected economic data have led investors to price in a higher peak in the Federal Reserve’s rate-rising cycle.

“We may have started a new year, but investors should still be prepared for a bumpy ride. The good news of higher bond yields is that they are getting paid to prepare.”

Written by: Timothy Moore @AFR.com

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