Protection From The Downturn: Finding Stocks That Do Well in Recession

It seems like a severe case of bad timing that a world that had been left reeling from the 2008 financial crash is set to face the largest recession in nearly a century. 

Naturally, it’s always going to be a case of bad timing when a virus as deadly as COVID-19 arrives. For the millions, perhaps billions of people who have been affected by the virus – whether in terms of health or a loss of income – the global economic downturn that’s set to follow could compound their misery. 

While it can take six months to ascertain whether a recession has occurred, the Business Cycle Dating Committee of the National Bureau of Economic Research has already confirmed that the US entered a recession in February 2020. 

Economic forecasts predict second-quarter GDP drops of as much as 30% to 40% in the US, with other nations worldwide facing up to similarly stark figures. The financial after-effects of 2020’s seismic loss in business could be felt for some time into the new decade as a result.

Despite the justifiably gloomy readings, the arrival of a significant recession doesn’t necessarily mean that investors should batten down the hatches and hide from the stock market. Investment opportunities are still emerging and there could be some potentially healthy returns for strategically constructed portfolios. With this in mind, let’s take a look at some of the most effective ways of finding stocks that may perform well in a downturn:

Strategising Your Investments

When a recession occurs, it’s important for investors to exercise caution but stay vigilant when it comes to monitoring the market for new opportunities to discover profitably assets at much lower prices. The harsh reality of recessions is that they’re profoundly difficult environments to navigate, but with enough research, there can be excellent opportunities for investors. 

In times of recession, the worst-performing assets tend to be highly leveraged, cyclical and largely speculative. If any investments fall into these categories then the company can carry a high risk of going bankrupt amidst the uncertainty. 

However, companies that are proven to have good balance sheets, relatively low debt and strong cash flows within industries that perform well in economic downturns could hold plenty of value for investors. 

(Images: Forbes) 

Writing for Forbes, John Jennings reports that stock markets can often be relatively safe places to invest during downturns due to how quickly it adapts to economic hardships. Underlining the point about the stock market’s ability to recover fast, Jennings highlights the S&P 500’s sustained recovery following the 2008 crash. While the road to recovery was littered with further hardships in the US, such as peaks in unemployment and the downgrading of the national treasury, the market reached a 528% return at the beginning of 2020’s crisis. 

Knowing Where The Risks Lie

While it’s important to be aware of which stocks are likely to rise during a recession, it’s equally imperative to be aware of which assets to avoid. Highly leveraged, cyclical and speculative assets and companies alike should be treated with caution while economies recover. 

During recessions, the level of debt incurred by highly leveraged companies could cause them to suffer significantly in the face of higher interest payments. This, in turn, could lead to a level of unsustainability that may force the company to downsize or even shut down. 

Fundamentally, the more leveraged a company is, the more susceptible it may be to the tightening of credit conditions when recessions occur. 

The reason why investors should steer clear of cyclical stocks is that they’re typically linked to employment and consumer confidence – both of which are prone to suffering in times of recession. Due to this, cyclical stocks tend to be excellent performers in bull markets when disposable income levels are high among consumers who have the freedom to purchase more luxury and non-essential goods. However, when jobs are at risk and difficult times are on the horizon, there could be very little profit to make from investing in cyclical stocks. 

Unsurprisingly, speculative stocks also tend to flounder during downturns. This is due to the fact that they’re based on shareholder optimism, which is largely put to the test during recessions. Historically, it’s speculative stocks that have performed the worst in recession markets. 

It’s important to steer clear of speculative stocks because they haven’t yet proven their value and are highly risky. Much like the case with cyclical stocks, speculative investment opportunities tend to become attractive propositions only in times of bull markets. 

Looking For High Performers

It’s understandable that some investors may choose to avoid dabbling in the stock markets during a recession, but there are still plenty of opportunities to pursue even when the economic outlook starts to turn gloomy. Historically speaking, many companies actually perform better than ever in times of financial hardship, while there could also be value found in investors backing counter-cyclical stocks for companies that are able to show strong balance sheets in healthy industries. 

Companies that can show strong balance sheets prove that they’re capable of performing in adverse financial climates. This can particularly be the case with businesses that operate in utilities, basic consumer goods conglomerates and defence industries. Diversified portfolios in times of recession may do well to include businesses from each of the aforementioned industries. 

If you’ve been following the economic forecasts surrounding the fallout of the COVID-19 pandemic, it can seem like every industry is set to suffer heavy losses. While there’s set to be plenty of difficulty for countless industries worldwide, there are some that are relatively recession-resistant. 

(Image: Investopedia)

Looking at the table above, reported by YCharts, it’s clear to see a theme emerging from 2008’s crash regarding the best-performing companies during the downturn. Essential services in health, haulage and air travel performed well, while discount stores proved particularly popular. The inclusion of Hasbro games shows that home-based leisure activities also proved to be highly popular. 

Here it’s worth pointing out that 2020’s crash will affect different industries due to the effects of lockdown and closed borders. For instance, global airlines have struggled with many companies forecast to go bankrupt as the recession rumbles on. However, it’s reasonable to expect plenty of recession resistance emanating from board game manufacturers again and discount stores. Health supplies are likely to perform significantly well as well as technology that facilitates remote work. 

The rise of video conferencing software like Zoom has shown that remote collaborative technologies have been performing extremely well as the pandemic forced widespread closures of businesses and led to more companies working from home (WFH). With the success of WFH felt in a range of industries coupled with the prospect of businesses having to downsize office space, this kind of technology could provide great investment opportunities throughout 2020 and beyond. 

Investing Your Way Into The Recovery

While it may seem like it’s far in the future right now, it’s worth thinking about your actions once the transitional economic period from recession to recovery begins. This is where the financial landscape begins to be punctuated by lower interest rates and steady growth. 

When this occurs, the previously dangerous, high-risk investment opportunities like cyclical and speculative stocks begin to offer value to investors. As economic conditions slowly begin to normalise, it’s these stocks that are likely to show signs of bouncing back earlier and will likely ride a wave of new optimism. 

There will be plenty of scope for investors to ‘catch the bottom’ of falling speculative stocks. But while there can certainly still be optimism for investors in the face of a looming large recession, it’s also worth remembering that the coming downturn will eclipse that of 2008’s crash – and will likely amount to the worst of its kind in generations. With this in mind, past comparisons can only be considered as advisory – and any investment will be a venture into uncharted territory. This means that there’s a greater risk of losses occurring, but also plenty of opportunities to be taken.