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- Investors are too optimistic about a potential soft landing of the economy, according to JPMorgan.
- The bank said to shift to underweight stocks and play defense as financial conditions deteriorate.
- These are four stock sectors best positioned to outperform in the second half of the year, according to JPMorgan.
A soft landing in the economy doesn't look as probable as some investors might think, according to JPMorgan's Marko Kolanovic — and there are a handful of stock sectors that investors should look to for protection as the economic outlook becomes murkier.
The chief global market strategist said in a Monday note that there's only a 35% chance of a soft landing materializing, and that the chance of a recession happening within the next year is still higher than most expect at 65%.
Given that outlook, stock valuations are too high and investors should be prepared for pain in equities during the second half of the year.
"With developed market central banks unlikely to ease near-term, ongoing quantitative tightening and our base case for macroeconomic slowdown, multiples look too high," Kolanovic said. "We disagree with the market's expectation that soft landing is the most likely outcome."
Kolanovic highlighted that defaults are beginning to rise as credit conditions tighten, "suggesting that a credit cycle has already emerged."
On a year-to-date basis, the total of high-yield and loan defaults has already surpassed last year's full-year total and is on track to be the market's third largest annual default total, according to the note.
As such, investors should look to defensively position their portfolio in the second half of the year by underweighting stocks altogether, and to shift to overweight cash and commodities.
"Commodities price in by far the highest risk of recession and stand out as under-valued, under-owned, and backed by compelling fundamentals and technicals," Kolanovic said.
In addition to cash and commodities, Kolanovic said investors should look to "pure defensive" stocks to outperform in the second half of the year.
Those "pure defensives" include stocks from the utilities, healthcare, consumer staples, and telecom sectors, according to the note.
"These sectors are [historically] some of the best performers around the last Fed hike in the cycle," JPMorgan said in a separate Monday note. The market currently expects that the Fed's most recent July interest rate hike was the last of the current cycle, with interest rate cuts likely sometime in 2024.
Also helping out these defensive sectors is the fact that market cap concentration in the stock market, particularly in the technology sector, is the steepest on record based on more than 60 years of history. That should benefit defensive sectors as investors eventually rotate away from concentrated positions.
"The current setup therefore presents an attractive entry point into cheaper defensives, especially if investors eventually re-focus on a more cautious view of the economy in [the] second half of 2023," Kolanovic said.