BlackRock shares a 2-part stock-trading strategy for an expected downturn in stocks as the Fed forces the economy into a recession with higher rates

  • Good news on the economic front is bad news for investors, BlackRock says.
  • With inflation still elevated, a strong economy means the Fed will push on the gas pedal more.
  • To avoid the resulting downturn, invest in short-term Treasurys and emerging market stocks, the firm says.

For a brief moment, good news was once again good news for investors. Now, good news appears to once again be bad news. 

The US economy has so far been resilient in the face of the Federal Reserve‘s aggressive tightening regime. Ordinarily, that would be a positive thing for investors if inflation were coming down as fast as the Fed would like. But price growth is proving sticky — consumer prices were up 6.4% year-over-year in January, down slightly from 6.5% in December — and an intact economy gives the Fed permission to continue hammering away at consumer demand via rate hikes.

Eventually, that will weigh on economic growth and hurt stocks, BlackRock said in a commentary on Tuesday. 

“We don’t think inflation is on track to return to policy targets – and a recession would be needed to get it down. That means solid activity data should be viewed through its implications for inflation,” said Jean Boivin, head of the BlackRock Investment Institute, in the commentary. 

“In other words: Good news on growth now implies that more policy tightening and weaker growth later is needed to cool inflation,” he continued. “That’s bad news for risk assets, in our view.”

Over the last year, the Fed has raised rates from near-zero to 4.5%, instituting four consecutive 75-basis-point hikes along the way, the fastest pace in decades. Many argue that these tightening measures haven’t yet worked their way into the economy, and the Fed has said they still have more to do to return inflation to its 2% target. Several Wall Street banks as a result have said the US economy will likely head into a recession in 2023

Given recent developments around inflation and the labor market — and the risk it creates for stocks and the economy — Boivin and his team have come up with a “new playbook” for their investing strategy over the next six to 12 months. They said they favor two trades in particular for both returns and downside protection.

2 trades for weak growth ahead

The first of the trades is to step into short-term government bonds. The firm said their prices shouldn’t fall too much further with yields already high. They also offer attractive returns. 

“We increase short-term Treasuries to an overweight. The jump in yields — the two-year U.S. Treasury yield is now near 4.6% compared with 1.5% a year ago — that now means short-term bonds provide income,” Boivin said. “We also like their ability to preserve capital at higher yields in this more volatile macro and market regime.”

The Vanguard Short-Term Treasury ETF (VGSH) and the Schwab Short-Term U.S. Treasury ETF (SCHO) are two vehicles for gaining exposure to short-term government bonds. 

Second, Boivin said he likes emerging-market stocks because they’re priced to reflect coming economic downside more so than stocks in developed markets. 

“We prefer EM as their risks are better priced: EM central banks are near the peak of their rate hikes, the U.S. dollar is broadly weaker in recent months and China’s restart is playing out,” he said. “That is in contrast to major economies that have yet to feel the full impact of central bank rate hikes – and yet still have a too-rosy earnings outlook, in our view.”

The iShares MSCI Emerging Markets ETF (EEM) and the SPDR Portfolio Emerging Markets ETF (SPEM) offer exposure to emerging-market stocks.