US investors are underestimating how painful a recession could be for some companies, strategist says

• US asset prices aren't yet reflecting the risk a recession poses to companies, a leading strategist says.
• Cyclical or heavily indebted businesses could struggle in a downturn, Simplify's Michael Green said.

US investors have punished growth stocks such as Tesla and Meta this year, but they're yet to sour on other assets that could suffer if a recession hits, a leading strategist has warned.

"We have largely seen a correction on the basis of the high-flying, richly valued names," Michael Green, chief strategist at Simplify Asset Management, told Yahoo Finance on Thursday.

"We're not seeing any indication that markets are really trying to price in a recession per se by letting the more cyclical or more levered components of the market really deteriorate," he continued.

In other words, companies with sizeable debts could struggle to refinance or repay them as interest rates rise and liquidity dries up, while businesses that are sensitive to the health of the wider economy could also run into trouble in a downturn. Yet their stock prices and credit spreads don't yet reflect those risks, in Green's view.

Green suggested that stocks have retreated this year largely because investors have rebalanced their portfolios, not because of recession fears. The Federal Reserve's interest-rate hikes have driven down bond prices, spurring some investors to sell equities to maintain their preferred ratio of stocks to bonds, he explained.

The Fed has approved seven hikes this year, lifting its benchmark rate from almost zero in March to over 4% today. The US central bank's goal is to beat back inflation, which surged to a 40-year high of 9.1% in June, and remained above 7% in November.

Higher rates can cool the pace of price increases by deterring spending, borrowing, and hiring. However, they can also pull down asset prices, hammer companies' profits by eroding demand and drying up financing, and drag economies into recession.

Green, a portfolio manager at Simplify, touted high-quality companies with large and stable profit margins, and minimal need to refinance or tap credit markets, as likely winners in 2023.

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