Repeated predictions of an imminent U.S. recession over the past few years may have paved the way for investors to weather the downturn when it does arrive. Northwestern Mutual Wealth Management chief investment officer Brent Schutte told CNBC that his team is shifting investments to cheaper stocks that are likely to hold up in a downturn because those sectors have already been hit. “The world has been talking about a recession for almost two years, and people have been investing that way,” Schutte said. When investment professionals say stocks are cheap, they usually use valuation metrics. Schutte said the price-to-cash-flow ratio for the S&P Small Cap 600 Index is already at a level that is typical at the end of a recession. Stocks of different sizes have performed very differently this year. The S&P 500 Index is up 14.5% so far this year, while the Russell 2000 Small Cap Index is up just 1%. The S&P 600 small cap index is down nearly 2% year to date. .RUT YTD Small caps are lagging behind large caps. CIO said Northwestern, which manages more than $280 billion in assets as of the end of 2023, is generally underweight equities but overweight small and mid-cap stocks in preparation for a possible recession. “I think in some ways stocks are already priced into that. That doesn’t mean they won’t fall if a recession occurs, but I think they’re priced into some of it. If that happens, I think the economic headwinds will turn into tailwinds and that part of the market will do well,” said Schutte, who earned his MBA from the University of Chicago Booth School of Business. The U.S. economy has defied recession predictions since its initial recovery from COVID-19-era health restrictions. But signs of stress have been mounting recently, including rising credit card default rates, sluggish consumer spending and a softening job market. “I still think a recession is possible because I think the longer interest rates stay high, the more they will ripple through the economy and ultimately the market,” Schutte said. But even if the Fed is able to steer the economy to a soft landing, Schutte said, a bet on small caps could pay off. A longer economic expansion would probably see a broader group of winners, he reasoned. A broader rally could be seen not just in small caps, but also in equal-weighted funds such as the Invesco S&P 500 Equal Weight ETF (RSP). The fund has less exposure to names like Nvidia and Microsoft than traditional index funds, and is up about 4% this year. Small-cap index funds like the iShares Russell 2000 ETF (IWM) are a cheap and easy way for investors to get exposure to that segment of the market, but Schutte said his team uses actively managed funds in its small-cap allocation.
