Protecting portfolios against recession risk
Consumer staples and healthcare have proven most resilient in a slump
There has been increasing talk of recessionary risks in recent weeks, with at least one global bank formally predicting a United States recession in 2023.
That’s certainly possible, although a lot can change in the space of a year and nobody has a perfectly working crystal ball.
Some would say economists make big calls like that to get headlines, ensuring they’ll be remembered as the first to predict it, even if they’re a little early.
At the same time, recessions are an inevitable part of the business cycle so it’s a matter of when, not if. At the moment, some of the typical ingredients for recession are indeed falling into place so we’d be na¨ıve to rule it out as a possibility.
A US recession would mean a global downturn is on the cards. The US is the world’s biggest economy so it’s pretty tough for the rest of us to escape unscathed if it slumps.
For sharemarket investors, recessions aren’t particularly enjoyable. The five biggest US sharemarket declines of the past 50 years all came in the wake of recessions.
Recessions lead to higher unemployment, lower confidence, falling house prices and a decline in consumer spending. This all feeds into weaker economic activity, pressuring corporate earnings and causing share prices to fall.
There have been four US recessions since the 1980s. There was the 1990 recession, the one associated with the dotcom crash in 2001, the GFC between 2007 and 2009, and the brief Covid-19 recession of 2020.
The S&P 500 fell heavily in all of these, and all the main eleven market sectors declined.
However, the two most resilient sectors have been consumer staples and healthcare. On all four occasions, both outperformed the broader market.
That’s not surprising. Companies in these sectors tend to be lower risk, more defensive, and less exposed to the ebbs and flows of the economic cycle.
Consumer staples companies are in the business of necessity, and even during a recession we still buy shampoo and toilet paper. Demand for healthcare services also tends to be quite stable, and its often the last thing we scrimp on if forced to tighten our belts.
At the other end of the spectrum is financials, which was the worst performing sector during those four recessionary periods.
While banks find themselves in vogue with investors as interest rates are rising, they aren’t a great place to be during a downturn. Bad debts tend to increase, and people hunker down rather than rushing to borrow more.
After financials, the next worst performer during recessions has been technology. That’s an interesting one, and the tech bulls would note these numbers were dragged down by the dotcom crash 20 years ago, when the sector was belted.
These days, some tech companies are almost utilities, which should see them hold up better during a rough patch. Businesses won’t easily do without Amazon’s cloud services or the Microsoft suite of products.
Then again, the Covid-19 recession was an oddball one too, which saw tech stocks perform strongly because we were all stuck at home using online shopping and video conferencing. That example probably flattered the numbers for the tech sector in this analysis.
Looking at companies on a sector basis doesn’t work quite as well in New Zealand. Our market is much smaller, and the idiosyncrasies of individual stocks can distort things.
However, the same principles apply. One would expect the large, stable defensive ones to hold up best in any downturn, while those tied more closely to the economy or with greater dependence on consumer spending could suffer most.
If we’re headed for recession, even a mild one, markets will remain under pressure. The best defence for investors is to hold a little more cash than usual, add to good quality fixed income, and ensure share portfolios are widely diversified with a tilt to the more resilient sectors.
Mark Lister is Head of Private Wealth Research at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.