The S&P 500 has extended its upward momentum, gaining 1.27% over the past five days and 11.46% over the past month, as easing oil prices boosted overall risk sentiment. The recent pullback in energy prices has provided a near-term tailwind for equities, helping sustain the market’s bullish tone.
However, this strength may be masking underlying risks. The rally, driven in part by declining oil prices, could be leading investors to underprice key macro concerns, particularly the risk of a potential recession and the broader impact of ongoing energy market disruptions.
Even amid recent hostilities near the Strait of Hormuz, a wave of optimism around a potential peace deal has pushed oil prices lower. The U.S. benchmark, West Texas Intermediate crude (WTI), slipped below the $100 per barrel mark, declining 11.19% over the past five days.
That said, price action has remained largely headline-driven since the onset of the Middle East conflict, limiting visibility on near-term direction. With meaningful diplomatic progress between Washington and Tehran still elusive and no clear pathway toward a lasting resolution or the reopening of the Strait of Hormuz, geopolitical risks are likely to persist, keeping oil markets volatile and reinforcing uncertainty around the broader macro-outlook.
According to Amrita Sen of Energy Aspect, global economies risk “sleepwalking” into a significant recession, with markets continuing to underprice the impact of the recent oil price shock, as quoted on CNBC.
Assessing the Likelihood of a Recession
Sen states that equity markets have remained resilient despite surging oil prices, highlighting a disconnect between rising geopolitical risks and market performance. Typically, elevated oil prices weigh on growth and equities, suggesting markets may be underestimating the broader macro impact.
As per Sen, as quoted on the abovementioned CNBC article, this divergence reflects “extremely misplaced euphoria” among investors, who appear to be dismissing the ongoing energy shock as a localized issue rather than a global risk. However, with energy costs feeding into inflation and growth concerns, such complacency could leave markets vulnerable to a sharper repricing if risks begin to materialize.
Adding to this, noted economist Gary Shilling, widely recognized for his bearish stance on markets, anticipates growing economic and market headwinds. As quoted on Business Insider, Shilling warns that a U.S. recession this year is “almost inevitable,” citing rising vulnerabilities across the economy. He expects a sharp equity correction as well, with the S&P 500 potentially declining by as much as 30% as elevated valuations come under pressure.
Per Shilling, several indicators point to a weakening backdrop, including a stagnant housing market, a sharp slowdown in capital expenditures and an emerging strain in consumer spending, which accounts for nearly two-thirds of economic activity. However, Shilling also states that a meaningful fiscal stimulus or sustained strength in the U.S. consumer could avert a downturn, neither of which he considers likely.
How Investors Can Position as Risks Build
Investors have increasingly adopted a “sell first, ask questions later” mindset. Even without a confirmed recession, a rising probability alone can weigh on markets, as profit-taking and risk aversion trigger broader sell-offs.
Still, positioning ahead of uncertainty is often more effective than reacting after losses materialize. Proactive allocation allows investors to manage downside risks better instead of playing catch-up in volatile markets.
Instead of adopting an overly bullish or bearish stance, a balanced and diversified approach remains key. With recession risks still lingering, the outlook remains uncertain, warranting a pragmatic strategy that prepares portfolios for a range of potential scenarios, helping mitigate downside while preserving upside participation.
Investors are better served by maintaining a long-term investment approach rather than attempting to time short-term market movements. For long-term investors, broadening exposure and diversification are essential to preserving growth prospects while reducing vulnerability to concentration risks.
Enhancing Portfolio Resilience Through ETFs
In the current macroeconomic backdrop, investors may consider increasing exposure to defensive ETFs, with capital preservation and downside protection as primary objectives. These ETFs can offer a dual advantage, shielding portfolios during periods of stress while still providing market participation and upside potential if market conditions improve.
Defensive sectors can provide resilience during downturns without fully sacrificing growth opportunities, making them a valuable component of a balanced portfolio. While the likelihood of a U.S. recession remains uncertain, a cautious and diversified approach can help investors better navigate evolving risks.
Against this backdrop, several areas stand out where investors may consider expanding their exposure.
Quality ETFs
Amid market uncertainty, quality investing emerges as a strategic response as a potential buffer against potential headwinds. This approach prioritizes identifying firms with robust fundamentals, consistent earnings and lasting competitive strengths. Investing in such high-quality companies can mitigate volatility for investors.
Investors can look at funds like iShares MSCI USA Quality Factor ETF QUAL and Invesco S&P 500 Quality ETF SPHQ.
Utility ETFs
As a low-beta sector, utilities are relatively shielded from market volatility, making them a defensive investment and a safe haven during economic turmoil. Investors often turn to utilities during downturns due to the steady demand for these companies' services.
Investors should gain from funds like Utilities Select Sector SPDR Fund XLU and iShares U.S. Utilities ETF IDU.
Value ETFs
Investors can leverage value investing, a strategy particularly compelling in today’s economic environment. Value investing through ETFs offers investors an easy and accessible way to follow this strategy. Value ETFs focus on stocks characterized by strong fundamentals and robust financial health, which trade below their intrinsic value.
Investors can consider Vanguard Value ETF VTV and Avantis U.S. Large Cap Value ETF AVLV.
Boost Your Portfolio with Our Top ETF Insights
Zacks' exclusive Fund Newsletter delivers actionable information, top news and analysis, as well as top-performing ETFs, straight to your inbox every week.
Don’t miss out on this valuable resource. It’s free!
Get it now >>Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
State Street Utilities Select Sector SPDR ETF (XLU): ETF Research Reports
Vanguard Value Index Fund ETF Shares (VTV): ETF Research Reports
iShares MSCI USA Quality Factor ETF (QUAL): ETF Research Reports
Invesco S&P 500 Quality ETF (SPHQ): ETF Research Reports
iShares U.S. Utilities ETF (IDU): ETF Research Reports
Avantis U.S. Large Cap Value ETF (AVLV): ETF Research Reports
This article originally published on Zacks Investment Research (zacks.com).