According to a recent report by Ned Davis Research, the economy is showing signs that investors should consider shifting towards defensive stocks. One key indicator that strategists are pointing to is the contraction in the M2 money supply, which has been shrinking in real terms since the beginning of 2022. This contraction historically has preceded the start of a recession and has generally favored defensive stocks over cyclical stocks.
The M2 money supply has been distorted due to actions taken by the Federal Reserve in response to the pandemic. While the Fed initially grew its balance sheet to add liquidity to the markets, it has since been reducing its balance sheet to combat inflation, leading to a contraction in the money supply.
Ned Davis Research suggests that investors should consider sectors like healthcare, consumer staples, and utilities, as these sectors have historically performed well in environments where the money supply is contracting. The strategists at the firm also note that consumer staples and healthcare have been the best-performing sectors when the M2 money supply is running below its long-term average.
While some forecasters, such as economist Steve Hanke, have pointed to the contraction in the money supply as a potential warning sign for a recession, the consensus on Wall Street is that the US economy remains on solid footing. Despite concerns about inflation and the contraction in the money supply, economists surveyed by Bankrate see the odds of a recession in the next year at just 33%.
Overall, the signals from the economy are suggesting that investors may want to consider defensive sectors in their portfolios, but the broader economic outlook remains positive according to most experts.