How to Identify Recession Proof Stocks
With high inflation, rising interest rates and a slowing economy, there are some wondering whether a recession could be looming. If so, what happens to stocks in a recession? What are the best recession stocks to watch during a downturn?
In this article, we will take a look at historically recession proof industries and see if, by doing so, we can learn how to identify recession proof stocks.
Table of Contents
What Is a Recession?
The economy follows a pattern known as the economic cycle, which consists of four stages. It starts with a period of economic expansion, which eventually slows before peaking. After its peak, the economy contracts, falling until it stops and begins to recover.
This period of contraction within the economic cycle is known as a recession and is traditionally defined by two consecutive quarters of negative economic growth.
What Happens to the Stock Market in a Recession?
The stock market generally moves in tandem with the economic cycle. When the economy is expanding, consumers have more confidence and buy more things which boosts profits.
Conversely, when the economy enters recession, consumers lose confidence and become more protective of their income. Consequently, consumption falls and so too do profits which impacts share prices.
In addition to this, the stock market suffers from the psychological impact of a recession. When the future of the economy begins to look uncertain some investors choose to liquidate their stock holdings in an attempt to avoid potential losses. Consequently, share prices fall which can cause panic amongst other, less-experienced, investors who sell their shares out of fear, pushing prices down further.
However, this is somewhat of a generalisation. Not all stocks are the same and, consequently, not all stocks behave the same throughout the economic cycle. Cyclical stocks tend to be worst affected by a recession but some industries can emerge relatively unscathed and, sometimes, with gains. So, how do we identify these recession proof stocks? What are the best recession stocks to watch during a downturn?
Historically Recession Proof Industries
As we mentioned in the last section, not all stocks react in the same way during a recession. It is also important to note that not every recession is the same, meaning that what constitutes the best recession stocks largely depend on the economic circumstances at the time.
For this reason, it is not possible to provide a definitive list of recession proof stocks. However, what we can do is identify a number of industries which, historically, have demonstrated resilience to economic downturns.
When investors are looking for recession proof shares, they look for companies which can rely on constant demand for their goods or services, regardless of what is going on in the wider economy. These type of companies are often referred to as defensive stocks.
It is a given that, during a recession, many consumers will attempt to cut unnecessary costs where possible. Therefore, in order to find potentially recession-resistant stocks, investors need to identify areas of spending which are likely to be prioritised by consumers.
In the following section, we will look at three examples of historically recession resistant industries.
Consumer Staples
There are various types of products which consumers will continue to buy regardless of what is happening in the wider economy. Food, drink and personal hygiene products are all examples of consumer staples which people demand throughout the economic cycle.
For this reason, this is typically thought of as an example of a recession proof industry and companies which produce or sell these goods tend to be thought of as recession proof stocks. Here are a couple of examples of these companies:
- Tesco: By far the most popular supermarket in the UK, commanding a market share of around 27%, Tesco should be able to rely on steady demand throughout economic uncertainty and even recession. Consequently, Tesco could be one of the UK recession stocks to watch in the event of a downturn.
- Procter & Gamble (P&G): One of the largest consumer goods companies in the world, P&G owns brands such as Vicks, Oral B, Fairy washing up liquid, Pampers and Herbal Essences. Thanks to its wide range of big-name brands, each of which produces various consumer staples, P&G is well-positioned to perform well during a recession. Other similar consumer goods companies include Unilever and PepsiCo.
Healthcare
Peoples’ health and general well-being does not pay attention to the economic cycle and, typically, people cannot avoid seeking healthcare when it is required. For this reason, companies which operate in the healthcare sector tend to be fairly recession proof investments.
- Vertex Pharmaceutical: Vertex is a biotech stock which manufactures drugs to treat rare genetic diseases, primarily focusing on the treatment of cystic fibrosis. People who need these types of crucial treatments will need them regardless of the economic situation.
- UnitedHealth Group: UnitedHealth offers both healthcare products and insurance services and is the largest healthcare company in the world by revenue. A healthcare company of UnitedHealth’s size is likely to be able to rely on consistent demand making it a potentially recession proof stock.
Utilities
As with healthcare and consumer goods, people need utilities and are likely to prioritise paying utility bills over other less necessary spending. Therefore, gas, electricity and telephone providers can generally rely on a stable level of demand throughout the economic cycle.
This might make these companies less exciting and rewarding to invest in during an economic expansion; however, during a recession, this consistent demand is the kind of quality required for recession proof stocks.
- Centrica: Centrica is an energy and services company which provides electricity and gas to consumers across the UK and Ireland under a variety of brand names, including British Gas. In total, they provide services to over 10 million customers.
- National Grid: Another British company, which owns and manages electricity and gas transmission networks across Great Britain, where it has a near total monopoly, and also in the northeast of the United States.
Identifying Recession Proof Stocks
This is not an exact science and there is no definitive list of recession proof stocks. Whilst we can identify recession resistant industries that have historically done well during market downturns, it depends largely on the specific economic climate at the time.
As well as identifying recession proof businesses that have the ability to perform well during an economic contraction, there are further factors to consider, such as changing consumer behaviour.
In 2008, the S&P 500 slumped by 37%, its worst total annual return since the Great Depression in 1931. However, as bad as that year was for the wider stock market, not all stocks fell. In fact, looking specifically at the S&P 500, a handful of companies recorded impressive gains.
But it is some of the specific companies who excelled that year which is telling. Of the top ten performers in the S&P 500 that year were Dollar Tree, Walmart and Ross Stores which posted impressive total annual returns of 60.8%, 20% and 17.6% respectively.
These three companies are popular low-cost retailers and their positive performance reflects the fact that, during an economic downturn, consumers tend to cut costs where possible, to the benefit of these types of companies. So, low-cost retailers are something to consider when looking for recession proof stocks.
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Recession Proof Stocks – FAQ
What Industries Are Recession Proof?
Whilst no industries are 100% recession proof, there are a number of industries which have historically proven to be relatively resistant during a recession. Examples of these recession resistant industries include healthcare, utilities, consumer staples and low-cost retailers.
What Stocks Do Well During a Recession?
Stocks which operate in defensive industries, such as consumer staples and healthcare, may be positioned to perform well during a recession. This is because these types of companies tend to produce goods and services which can rely on a fairly constant level of demand from consumers.
Should I Hold My Stocks During a Recession?
Although it may be easier said than done, it is important not to panic during a recession and to make investment decisions based on logic rather than fear. It can be unnerving to see the value of your portfolio decrease during a market downturn but, remember, by selling your shareholdings you are cementing the losses. Recessions are a normal, albeit unwelcome, part of the economic cycle and you should factor this into your decision making process when investing.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.
