A recession has been a very popular word over the past couple years with the coronavirus pandemic going on and with Russia’s invasion of Ukraine.
Last Quarter (Q1), Gross Domestic Product (GDP) declined by 1.4 percent. If the current quarter (Q2) has a negative GDP, we will technically be in a recession. We will not know until Q2 is over and the numbers are announced.
These current events have led to shaky times in the economy, but we will show you in this article how to still be successful through some recession stocks.
What is a Recession?
A recession is a decline in economic growth (GDP) for two or more quarters – half a year.
Typically, during a recession, there is a significant drop in the stock market; the housing market is unstable, and there is a rise in unemployment.
The National Bureau of Economic Research (NBER) is the one who officially declares recessions in the United States. Their definition is a little different than the general public’s opinion.
They say a recession is a strong decline in economic activity that is spread across the economy that lasts a few months. NBER looks at real income, employment, industrial production, and wholesale-retail sales.
Causes and Effects?
A recession has many causes but let us take a look at three major influencers.
Economic Shock – An event that occurs spontaneously that creates financial havoc on the economy. In February of 2020, the NBER declared a recession in the US, due to economic shocks in the supply chain caused by the Coronavirus.
High Inflation – Inflation is what causes prices to rise over time. Too much inflation is a bad thing and the Federal Reserve will raise interest rates to combat it.
Raising interest rates reduces the amount of money people can borrow, which leads to a decline in economic activity. High inflation led to the recession of the early 1980s.
Large amounts of debt – Taking on too much debt is risky because it can lead to defaults and bankruptcies. The Great Recession of 2008 is an example of excessive debt causing a housing market bubble which crashed the entire economy.
How does a recession affect me?
Potential Job Loss: As the economy shrinks, companies tighten their budgets and reduce overhead as a reaction to less demand for their products and services.
Job security decreases, so it’s important to communicate with your team and managers about your role and its value preceding a recession.
Investments Loss (stocks, real estate, retirement savings): With every recession, your investments tend to get pretty hard. It can be easy to freak out and panic sell. You want to stick to your investing strategy and focus long term.
Prices rise (food, gas, clothes, etc.): One of the main reasons that we go into a recession is because of high inflation.
Inflation causes prices to rise, so you should budget accordingly. Figure out your day-to-day necessities and cut out luxury items to save money.
What Stock Sectors did well during past Recessions?
During a recession, the stock market becomes very hectic. The overall stock market tends to get hit, and some stock sectors do worse than others depending on the recession.
However, through all the smoke, there are some stock market sectors that are recession-resistant. The industry calls these “Defensive Sectors”.
Health care tends to be a safe investment during a recession. Within this sector, there are companies in pharmaceutical, health care equipment, biotech, and health care services.
The reason for health care outperforming others is that we buy health care products all the time and purchase them repeatedly. Some of these products include drugs, medical equipment, hospital supplies, and health insurance.
For example, if you are sick, you go to the doctor, and then go to the pharmacy to pick up your medicine.
Health care companies that have high debt and low cash flow tend to get hurt more during a recession. To be safe, look into health care companies with low debt-to-equity ratios and avoid startups.
Consumer staples is another sector that has outperformed during a recession. These products are always in demand because they are items people use every day. Such as, food, drink, personal products, and household goods.
Companies in this sector are doing business all the time regardless of the state of the economy.
In the chart below, Consumer Staples does its best, when a recession is approaching.
Source: Business Insider
The common theme between these three sectors is that consumers always demand these goods and services. Same thing for Utilities – water, electricity, and gas.
Some other companies within this sector are renewable energy and infrastructure (pipelines, cell towers, power lines, etc.) providers. Again, people will always need to pay their bills.
During a recession inflation rises, which causes prices to rise. People will have to budget properly to save money during tough economic times. They might have to give up luxury items, but they will have to pay utility bills, medical expenses, and will have to eat.
Investments to avoid during a recession
Avoid companies with a lot of debt on the balance sheet. This means they are more sensitive to high interest rates that come with a recession.
Investors will mark down stock prices to reflect the risk from having so much debt.
Typically during a recession, a business will suffer a decline in sales, and may not be able to pay interest on its debt. This can lead to default or bankruptcy.
History has shown us that stocks in the financial sector do poorly during recessions. During the great recession of 2008, the financial sector was ravaged by the crash of the housing market.
Two victims of this financial crisis were Lehman Brothers and Bear Sterns – both considered “pillars” of Wall Street. Bear Stearns was bought out by JPMorgan Chase for very cheap, and Lehman Brothers filed for the largest bankruptcy in the United States at the time.
The recession during the coronavirus pandemic hit some different sectors than previous recessions. The industries heavily impacted were Airlines, Hospitality, and Entertainment.
In April of 2019, more than 2 million travelers passed through United States airports every day. During the 2020 recession, air travel fell by 95% because of the pandemic. Cruise lines, sporting events, and casinos also had a drastic drop in attendance numbers.
There are several factors to consider to prepare your portfolio against a recession.
One of the best ways is to have a diversified portfolio. This means including stocks in the Health Care, Utilities, and Consumer Staples sectors. But also make sure your portfolio is dipping into industries all across the board.
Defensive sector stocks do tend to outperform during recessions; nevertheless they typically have lower growth rates during the recovery phase. That is why also investing in stocks with potentially higher growth rates like tech is a good idea.
An ideal company during a recession has the following characteristics:
– Low debt
– Strong balance sheet
– Positive cash flow
– Strong demand for their products
Bottom Line is you want to keep a long-term mindset and manage your risk as much as possible. A recession is only for a relatively short period of time, on average 11 months, so you should have an active investing strategy when the positive times return.
One final way to tackle a recession is to stop spending and build up capital to invest.
The stock market fluctuates all the time; you just have to stay disciplined and know eventually it will recover. If you believe in your investments, one thing you do not want to do is sell when they are at its lowest point.
When you think about it, that company is just “on sale” and a recession is a great time to buy more. That should be the case if the company has strong leadership, solid financials/books, and an optimistic plan for the future.
Expert Opinions on Recession Stocks:
Let’s take a look at two famous, but different in strategy investors and how they handle a recession.
Warren Buffett could be considered the poster boy for stock market investing. He is known for his value investing strategy and being the CEO of Berkshire Hathaway, which has the highest-priced stock on the market.
He is a seasoned veteran by surviving market crashes such as Black Monday in 1987, the dot-com bubble in 2000, and the 2008 financial crisis.
During these tough times, Buffet has a very bullish and long-term strategy. He advises investors to be aggressive when others are scared and to capitalize on cheap stock prices.
In a column with the New York Times, Buffett wrote “A simple rule dictates my buying: Be fearful when others are greedy and be greedy when others are fearful”.
Not everyone has Buffett’s patience and confidence, but he does give some solid advice on how to handle a recession.
In this past quarter (Q1), Buffet took advantage of the struggling stock market and purchased $51 billion worth of stock. Buffet is sticking to is investing strategy of buying companies when they have lower value.
Cathie Wood is the founder of Ark Invest, which is a fund dedicated to investing in high growth companies, with the potential to change the world.
The areas she focuses on are cryptocurrencies, artificial intelligence, renewable energies, robotics, and DNA sequencing.
Wood is not a fan of value stocks like Warren Buffet is; instead she focuses on growth stocks and “disruptive innovation”. Her investment strategy comes with a lot of risk, but the rewards are through the roof.
During the 2020 pandemic year, her fund returned 150% which is unheard of. Since then, her fund has erased most of its pandemic gains.
Wall Street has been very critical of Wood, saying she relies too heavily on her own instincts to build a portfolio. Wood’s response to the criticism is that “innovation gains traction during tumultuous times.
A recession is a scary time because it impacts everything around you. It is important to stay updated with the current state of the economy and how the stock market reacts. With summer right around the corner, check out our summer stock tips.
There is not one stock that is guaranteed to be recession proof, but there are characteristics to look for that will help limit your risk.
Invest in companies that have promising products and leadership with obtainable goals. If you can invest smartly during a recession, times of expansion have the potential to be glorious.