Stock market: Where to invest in a slowing economy

As the markets await the Federal Reserve’s decision on whether to raise interest rates this Wednesday, investors wondering where they can put their money to work in a slowing economy have some options.

Market watchers believe unemployment will rise if the Federal Reserve keeps interest rates higher for a long period of time in its effort to bring down inflation. Eventually though, the central bank is expected to pivot, or lower rates, in order to spur economic growth.

“Rates will be lower a year from now, and even lower two years from now than they are today. While they’re not going back to zero, they could go from 5.25% to 3% or even 2.5% over that period of time,” David Bailin, Chief Investment Officer at Citi Global Wealth Investments told Yahoo Finance.

His team laid out opportunities for investors in a recent report, given that backdrop.

Federal Reserve Chairman Jerome Powell holds a news conference after the release of U.S. Fed policy decision on interest rates, in Washington, U.S, May 3, 2023. REUTERS/Kevin Lamarque

Intermediate bonds

One option, he said, is moving cash into intermediate term securities.

“You want to move from a today interest rate to let’s say a 5-year interest rate, because you get two benefits from that. You get to capture the higher rate of interest for that whole 5 years. And if rates do go down, those bonds actually would appreciate in value,” he said.

Small and mid-size companies

When diversifying a portfolio, investors can should look at where valuations are cheapest, says Bailin. That includes smaller or medium sized companies, whose stock performance is 30% below the larger ones.

“So, why do you wanna do that? Because in a recovering period, those stocks [small and medium size] will be leaders, and because they’re less valued than the large caps,” he added.

Non-US equities

Citi Global Wealth Investments projects the US growth rate next year to be between 1% and 1.5%, and the global growth rate to be 2% to 2.5%, making non-US equities attractive.

“Growth ex-US is going to be larger, and our Federal Reserve is more likely to bring down rates faster than the European or other central banks. If that’s the case, you get two benefits: you get better growth outside of the US combined with the declining dollar, [which] equals higher dollar returns.”

“We expect some emerging markets, including China and Brazil, to ease monetary policy in the coming year. Given the backdrop of US rate cuts in the coming year, this should provide a boost to local markets and economies,” said the recent Citi report.

Specifically, Asian stocks are poised to benefit, according to Bailin.

“If you buy a PanAsian index today, you get the benefit of Asia’s growth rate and the fact that it’s the most sensitive to a dollar’s decline,” said the strategist.

Artificial intelligence

As far as sectors go, investors may want to consider companies which become more efficient through the implementation of artificial intelligence.

“If you look at industries that employ a lot of white collar employees— lower or medium level white collar employees, those are going to be deeply impacted by the technology,” said Bailin.

“So you can invest in companies that could do a great job improving their margins through that software development and software coding,” he added. The markets have responded positively to an AI craze this year, fueling a rally in tech and communication services stocks.

Biotech

Biotechnology stocks are trading at a discount compared to pharmaceutical companies, in part because many are speculative companies which have a harder time getting access to capital.

“When growth returns, which is 2024, we should see some biotechnology pickup,” said Bailin.

Some economists have dubbed the US economy’s slowdown a rolling recession. That means parts of the economy, such as commercial real estate are in contraction. However other parts, such as travel and leisure, are still growing.

A rolling recession makes picking the bottom of the market more difficult. Investors who stood on the sidelines since the beginning of the year lost out on gains.

On Tuesday, the Nasdaq (^IXIC) and the S&P 500 (^GSPC) both hit 52-week highs, up 25% and 16% since the start of the year, respectively.

“No one would’ve predicted the markets would be where they are today,” said Bailin. “By waiting for that period of time, they’re [investors] actually forgoing returns.”

Ines is a senior business reporter for Yahoo Finance. Follow her on Twitter at @ines_ferre

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