It’s evident, the US has slipped into a recession, although as of early June we have not yet seen two negative quarters of GDP growth. However the forecast for the second quarter is well into the negative numbers. This quantifies a systematic recession. Even through recessions, there are stocks that do well, or do not do as bad as others and rally well after the recession is over. So what stocks do well during a recession?
First we should talk about how to prepare for a recession. It’s always difficult to forecast one in terms of market price action, because the market reacts before we actually get the economic numbers. As it was the case this year, we already had a 35% slip in US equities months before we got the first quarter GDP growth in the US. Take a look at the image below, the green box is where the downside plunge happened, directly to the right of that green box, is the first negative quarter report. The recession news was already priced in.
How to prepare for a recession?
It’s very difficult to prepare for a recession unless you have anticipated it based on your own research. First to identify the potential downside in the market, when a cataclysmic event like Corona virus begins or something else we have to start thinking of the repercussions of said events. An indicator TRADEPRO likes to use is slowing economic data like jobs numbers, and drop in consumer spending, also consumer sentiment reports.
Watch the S&P 500 market, which is an indicator of the economy, as much as the politicians in the US like to discern that fact. The quick drop of the S&P 500 day by day is a very good leading indicator of these events. Look at the chart above, the first few days of the start of the decline happened very quickly. After the first 5% you should start considering a possible strong drop, especially if it happens in a very quick fashion. Once the downside opens up under the 10% mark then you have to get serious about taking action. Especially if it happens in a matter of days.
These are some steps you should consider when preparing for a recession from a financial point. These are both from a personal standpoint and should be considered for corporations that you want to invest in.
1. Make sure you have cash on hand (emergency fund)
Typically it is recommended that an individual has 3-months of expenses in cash. This is personal insurance should something happen to one’s job throughout an economic downturn. It’s easy to forgo this in a good economy but we should really consider this. The same goes for companies. A strong company that withstands a recession is one that has a lot of cash on hand, which is what differentiates those that go bust and those that survive.
2. Decrease spending.
In these circumstances, individuals drastically decrease spending as they should. Discretionary spending should be limited and focus on essential items. Take a look at your budget and find areas that are not necessary. If you don’t have a budget it’s time to consider making one. Take into consideration the 50/30/20 method. Where 50% of your income goes towards essential expenses, 30% to wants and 20% to savings. When getting prepared for a potential economic downturn, try to limit the wants spending and increase the savings portion. Companies that you should be interested to invest in should do the same. Decreasing their expenses to have more cash on hand prior to these dire times are companies you want to look at.
3. Manage debt.
Debt looms over a lot of people in the world, and it’s pivotal to come up with an attack plan especially in a potential recession. You may have less income in the future due to a recession and limiting the debt portion you have makes it a lot easier on you. This is the exact same when it comes to companies! When looking to invest in a recession or after the event occurs, look for stocks and companies that have low debt! Or proof that they use their debt effectively. If they have enough cash to cover that debt portion easily.
4. Check on your portfolio.
Finally what you’ve been waiting for. What kind of investments should you look for? How should your portfolio change if you are anticipating a market downturn? Typically as risk on, equities, rise investors flood into those assets. So when there is a downturn investors tend to switch from risk on to risk off and money flows into assets like bonds, and gold among other precious metals which are considered “safe haven” assets. Limiting your risk exposure in a recession limits the beating your portfolio will take.
Which stocks do well in a recession?
Stocks and companies can be categorized in different sectors, some do well in recessions and those are the ones we need to pay attention to. There are stocks that rebound really well throughout a recession that are good picks too. Let’s explore some of the options.
There are many sectors out there, and the ones that are essential are safer to consider in an economic downturn. Such as utilities, health and consumer staples. These sectors are essential no matter the economic circumstance and although they may not rise perse, they will most likely drop less than other risk on assets.
The utilities sector is full of companies that supply the basic amenities, like water, electricity, natural gas, sewage services and more. No matter the circumstances, people will always need these amenities to live. Which is the same as the consumer staples industry. The consumer staples are non-discretionary products pivotal to human survival. Such as food, beverages, household items, hygiene products and more.
In another category, there are risk on assets that may take a hit but have the ability to rebound faster and earlier than other companies. Those companies are cash heavy, with a lot of liquid assets on hand that area able to withstand strong economic downturns. Some may be big tech companies like Apple.
What stocks should be considered to be bought in a recession?
As we mentioned above, there are a few categories of companies that we want to consider in a recession. Those in utilities and consumer staples mainly and companies that are heavy on the cash at hand side. To add to this, consider large companies with a big market cap. These companies are much less likely to go under in the events of a recession. There could be some small caps in the utilities industry that do manage to fail.
In the utilities space. Consider some of the following, Duke Energy, National Grid and Dominion.
These utility companies took a hit throughout the initial downfall in the equity market but sustained a lot of their ground and managed to catch a good bid to the upside once there was talk of a recovery and market participants started buying equities.
Take a look at National Grid below, a pretty significant drop but sustained a lot of its strength at the beginning and halfway through the bear market. It rebounded before other risk on assets and is on a tear right now, soon to be back at all-time highs by the looks of it.
In the consumer staples space. Consider some of the following. Walmart, Costco and Procter & Gamble.
These companies are strong in downturning economic conditions, some even rising. They represent necessities that people need to purchase on a daily basis. The larger department stores like Costco and Walmart are less expensive which gives people the opportunity to limit their spending. Take a look at Walmart for example, throughout the downturning market, the stock slightly dropped, no more than 16% and then rallied well just days after. Even hitting new highs in most recent months as other equity markets struggled to get back to a moderately neutral standpoint.
In the large cap companies with a lot of cash on hand, the following companies showed a strong rebound and rebound potential, Apple, Microsoft, Facebook, Disney.
Finally, the large companies that did take a beating throughout the downturn in the overall market however they were good companies to consider as markets we dropped. They are large companies with a lot of cash on hand that can easily withstand a drop. Some of these stocks rallied into all-time highs in the most recent weeks. Even as the overall market is struggling. A lot of tech companies could be considered in this category, they do really well when markets start to make a run for the bull side.
Take a look at Facebook, the stock managed to rally into all time highs. The cash on hand and general innovation helped the stock pump higher after a large downturn. This stock has vastly outperformed the S&P 500 this year and there is more potential for a move higher.
There are a lot of stocks to choose from during a recession and a lot to consider when doing personal finances and looking at a company’s finances. Look at sectors that area necessities no matter the economic condition and larger companies that have the ability to rebound well with a lot of cash on hand to support their expenses and innovation.
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The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.