Look out for steady stocks in a recession
When the economy hits a slow patch, seeking shelter in pockets of the stock market where companies can still grow their earnings has long been a go-to investment strategy.
The reason is simple: How much money a company earns is one of the key drivers of stock price performance. So, with the U.S. economy now in a recession for the first time since 2009, and the Federal Reserve projecting that the nation’s GDP will decline 6.5% in 2020 and the unemployment rate will end the year at 9.3%, portfolio managers covet growth more than ever.
Indeed, the more insulated a company’s sales and profit streams are from economic woes, the more likely it is that their stock will perform better relative to companies whose profits suffer more during slowdowns.
Growth, it turns out, is good, and is viewed as a type of safety play on Wall Street.
“Safety is viewed through the lens of consistency of earnings growth – and not volatility of earnings,” says Joe Fath, manager of T. Rowe Price Growth Stock fund.
The attributes these types of companies share are similar no matter what type of business or industry they are in.
“What we’re looking for is a company that can grow no matter what,” says Thomas Martin, senior portfolio manager at GLOBALT Investments in Atlanta. “They are in the right spot in their industry versus their competitors. They have a competitive advantage, some sort of lead or moat. They will be taking market share rather than losing share.”
When it comes to generating steady earnings through both good and bad times, some industry groups tend to hold up better than others.
Some examples include:
Technology
Tech, known for innovation, productivity-boosting software and must-have apps that transform the way people live, work and communicate, is lauded for its growth characteristics. In the first quarter of 2020, tech stocks in the S&P 500 grew earnings 7%, vs. a drop of nearly 13% for the broad index. In the current quarter, which ends June 30, tech profits are seen declining 8.5%, compared with a nearly 43% contraction for the S&P 500.
Companies in the tech space are disruptors and drive societal trends with staying power. They’re at the forefront of longterm trends, such as the shift to a digital world, working from home, socializing and news gathering on smartphones, shopping online, streaming TV content, and storing reams of data in the cloud.
And being at the center of those trends creates demand for their products no matter what the broader economy is doing.
“Tech is the easy place to go or hide out regardless of what’s happening in the economy,” says David Reyes, founder and chief financial architect at Reyes Financial Architecture in San Diego.
He cites a company such as Zoom, a leader in online videoconferencing, a growing trend as the adoption of telecommuting and online worker collaboration gains a greater foothold in the economy.
“It’s a company that is economically agnostic,” Reyes says. “People will need to communicate via the web regardless of how the economy is doing.”
If there’s a downside to tech now, however, it’s that the group has had a stellar run and many of its popular stocks have had big run-ups, such as Zoom, Tesla, Visa and MasterCard. That’s why T. Rowe Price’s Fath is recommending tech stocks positioned in fast-growing areas that are selling at more reasonable prices relative to their earnings.
One less well-known play in the mobile pay space, for example, that is benefiting from the long-term shift away from people paying for things with paper money is Fiserv (FISV). The stock, which was among the T. Rowe Price Growth Stock fund’s top 20 holdings as of March 31, is trading at a much more reasonable valuation despite being a “very steady grower” and “relatively economically resistant,” Fath says.
Communications services
Since this group of stocks was realigned in 2018, growthier names such as video streaming service Netflix, search-engine Google’s parent Alphabet and social media giant Facebook are now in the lineup. The good news is such stocks as Facebook and Google not only benefit from durable earnings growth but now trade at a reasonable price relative to their earnings, Fath says.
Companies including Netflix, which GLOBALT’s Thomas says are on the “forward-looking side of change” also tend to grow faster than the overall market during periods of economic softness.
Health care
The need for knee replacements, medical diagnostics and surgeries doesn’t go down just because the economy isn’t firing on all cylinders. Increasingly, health care, too, is being driven by technological breakthroughs and apps that drive growth, Fath says. The use of robotics, for example, is powering the joint replacement surgery business of Stryker (SYK). And so-called telehealth services offered by such companies as Teladoc Health (TDOC), which enable patients to consult with their doctors virtually, also is in a growth sweet spot.
Utilities
Earnings of companies that provide everyday services like electricity also tend to hold up better when the economy slows, says Reyes, who advises investors to own stocks in defensive sectors that will provide stability in tough times. In the current second quarter, utilities companies in the S&P 500 are expected to see just a 3.3% drop in earnings, vs. a 40%-plus drop for the broader index.
Reyes points out that when economic growth slows, interest rates tend to fall as well. That makes higher-yielding stocks with steady earnings such as utilities a good place to park some capital, he says. The current yield on the 10-year Treasury note is around 0.70%, far below the 3.5% average yield of utilities stocks in the S&P 500, according to S&P Dow Jones Indices.
Similarly, companies that sell staples such as cereal and toilet tissue, Reyes says, also have historically seen their profits remain firm despite softness in the economy.
Reyes also says that investors also should be on the lookout for an eventual economic upswing. Buying stocks that benefit from a rebounding economy can be profitable if the purchases coincide with stronger growth. His favorite pick is so-called small-cap value stocks, or smaller companies whose shares are undervalued.