In recent weeks, global markets have been put under a tremendous amount of stress. Speculation that this unprecedented era of growth is now on the decline has increased. Market indicators such as the inverted yield curve on U.S. Treasury bonds have further pressured the bullish market, leaving the future uncertain for investors. With these troubling times upon us, the best thing to do is to prepare your portfolio for the worst to come: a recession. Recession-proofing your portfolio simply comes down to understanding the connections between businesses and customers in the event of an economic slowdown. Doing so will allow you to minimize losses before a recession, while also laying a strong foundation to rebound after a downturn in the market.
High Dividend Yields
Stocks with a high dividend yield are prime candidates for anchoring a recession-proof portfolio. Usually, larger corporations and ETFs hold the greatest dividend yields. The added buffer that the annual cash payout provided by high dividend stocks is invaluable for a recession-proof portfolio. By choosing stocks with high dividend yields, it helps to negate any cyclical properties of said stock, meaning the extra cash from the dividend will help to offset a general decrease in value of the stock in the event of a recession. Additionally, certain ETF funds are specifically designed towards maintaining a constant value, while also providing a highly-competitive dividend for investors to sit on during a recession. Researching stocks that have high dividend yields and solid fundamentals is a great first step in recession-proofing a portfolio.
Providers of the Essentials
Companies that provide essential goods or services, such as waste management or food, are what are known as anti-cyclical stocks. This means that such stocks aren’t tethered to the ups and downs of the business cycle. For example, in the event of a recession, people can’t simply stop eating or using running water. Certain expenses will remain necessary regardless of personal income. Therefore, investing in businesses that provide essential goods and services is necessary in rounding out a strong recession-proof portfolio.
Furthermore, companies that market addictive substances such as tobacco, alcohol, and/or caffeine are another sound investment for a recessionary period. Moral hazard aside, companies that sell addictive substances are excellent investments. Their customers won’t simply stop buying such products when money becomes tight. Instead, customers will most likely shave their budget around these products, until they truly cannot afford them anymore.
A good example is asking the question, “Would someone be willing to give up their daily cup of coffee with less disposable income?” The logical answer to this question is no because people who drink coffee are dependent on caffeine. Sure, there may be some exceptions, but for the vast majority, coffee will still be a daily expenditure. Following this chain of logic, look to invest in companies that sell products that people simply can’t live without.
Consumer entertainment (specifically the tourism industry) is on the opposite spectrum of what is regarded as essentials for living. For most people, a trip to Hawaii would probably be last on their expected expenditure list during an economic slowdown. For this reason, stay away from companies involved with tourism, such as theme parks and hotels.
However, in recent years, entertainment spending has evolved into a new form in that of streaming and subscription services. This new model for consumer entertainment brings promise to the entertainment industry during a recession for the same reasons as the coffee example. Footing a monthly streaming service bill for a little over $10 is a much more manageable expense compared to a week-long vacation to the Bahamas. Therefore, certain entertainment stocks that have shifted towards anti-cyclical can be surprisingly rewarding investments.
Tech stocks also go hand in hand with the consumer entertainment industry. Nowadays, the majority of consumer entertainment is delivered via screens and devices. This leads to a decrease in spending on entertainment would cause tech stocks to fall as well. Although tech stocks are huge winners in an expansionary period, they can also be huge losers during a recession. The uncertain nature of many tech stocks tends to make them ineffective for recession-proofing a portfolio. However, certain tech stocks can serve as solid, long-term asset holdings depending on the product or service they provide, which can be useful in a separate portfolio.
The current threat of a recession is an important reminder to investors that the markets are not invincible. Whether or not these fears will come to fruition is unknown. However, the fears brought by a potential economic slowdown serve as a good warning to investors to protect and manage their portfolios accordingly in a worst-case scenario. Recession-proofing your portfolio now through solid stock-picking skills will be one of the best defenses against asset losses in the future.