Market Volatility: Which Investments Will Protect Your Portfolio in a Recession?

Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton.

Investing Insights is helping investors navigate market volatility in a new series. Morningstar strategists and authors will deliver timely insights, trends, and tips. These episodes will pop into your podcast feed at least once a month.

This week’s episode focuses on which investments might be safer than others during a recession. The chances of one happening have increased quite a bit over the past few weeks. That’s according to Morningstar’s US economics team.

Amy Arnott has researched past recessions to identify which asset classes, investment styles, and equity sectors fared best and worst. The Morningstar Inc. portfolio strategist discussed her findings to help investors limit some of the damage.

Thanks for being here, Amy.

Amy Arnott: Sure. Thanks for having me.

Why Current Market Volatility May Not Be Ending Soon

Hampton: Fears of a recession are growing because of the trade war uncertainty. How does this current volatility compare to other times? But before you answer, let’s time-stamp our conversation. Today is Wednesday, April 16, just before 11 a.m.

Arnott: We saw market volatility starting to pick up around the end of February. As you know, we had the big spike in early April right after more specifics on tariffs were announced, and we saw a big two-day drop in the markets, when there was one day the market was down about 5%, then another 5% the next day. Since then, now that we’re in this 90-day pause, things have settled down a little bit. But if you look at the VIX Index, which is measuring market expectations for future volatility, it’s still pretty far above average at this point. So, we’re running about 30 or so with the VIX versus the long-term average of about 20. Definitely a period of heightened uncertainty and volatility.

How to Keep Yourself Steady During Market Volatility

Hampton: The recent up-and-down moves in the stock market have rattled investors. We’re told not to look at our portfolios. Some of us did, Amy. What about you?

Arnott: I had to look at my portfolio because I had to log in to make a transfer so that I could pay for my taxes. It’s never fun to see the number going down. Fortunately, in my case, it wasn’t too, too bad because I have a pretty well diversified portfolio. But I think in cases like that, it’s helpful to just take a step back and remind yourself, what am I investing for? What is my time horizon? Hopefully, you have an asset allocation that makes sense for your time horizon and your goals. If that’s true, then I think you can just reassure yourself that volatility is temporary. We do have downturns in the market from time to time. But the long-term trend in the market has historically been positive.

How Investors Nearing Retirement Can Avoid Sequence-of-Return Risk During Market Volatility

Hampton: Can you talk about how market volatility like this affects someone who’s planning to retire within the next five or 10 years?

Arnott: If you’re closer to the 10-year end of the range, it shouldn’t be a major issue. But as you get closer to five years before retirement, that’s what a lot of financial advisors will call the retirement danger zone for sequence-of-returns risk. That’s the issue where if you have a couple of down years in the market, there’s less time for your portfolio to recover before you retire and start taking portfolio withdrawals.

So, if you are in that five-year window before you plan to retire, that’s why it’s definitely a good idea to start derisking your portfolio and make sure you have some exposure to safer assets like cash and bonds, especially short-term to intermediate-term bonds.

How Retirees Can Mitigate Market Volatility Using the Bucket Approach

Hampton: What about current retirees?

Arnott: Kind of the same thing, where if you’re in the first five years of retirement, that’s the period when you have to worry the most about the potential impact of sequence-of-returns risk. That’s why the Bucket approach that we’ve written a lot about on Morningstar.com can make sense for a lot of people, where you set aside one to two years’ worth of portfolio withdrawals into cash, another five to eight years in fixed income or moderate-allocation funds, and then the remainder in stocks.

The benefit of that is I think it can be very helpful psychologically, because when you’re making withdrawals in a down market, you can take them from the cash bucket, and you don’t have to be drawing down stocks when the stocks are going down.

Which Asset Classes Have Performed Best and Worst During a Recession?

Hampton: Let’s get into portfolio performance. Which asset classes have performed best and worst during recessions, and why?

Arnott: Normally, stocks have had negative returns during most recessions. The reason is if you have a slowdown in economic growth, that means, for a lot of companies, they will see revenue growth, earnings growth, operating income growth declining, and that is normally reflected in their stock prices. Bonds usually are a safer place to be in recessions, partly because they have stable cash flows. When you buy a bond, you know exactly how much interest income you’re going to get and what the value of the bond is going to be at maturity.

So, people often will buy bonds as a safe haven during recessions. Then, another advantage of bonds during most recessions is that we often see the Federal Reserve moving to cut interest rates to stimulate the economy, which is positive for bond prices. That’s the reason bonds are usually a safer place to be. Then obviously cash. It’s not a growth asset over the long term, but it does hold its value in down markets and recessions.

What Investors Should Keep in Mind Before Going for Buying Gold

Hampton: Gold can serve as a hedge against market volatility. What should investors think about before buying the precious metal or buying a gold fund?

Arnott: We have seen a lot of people taking refuge in gold so far this year. As we’re recording this on April 16, I think it’s up about 23% for the year to date. But a couple of things to keep in mind would be one, gold itself, even though it’s viewed as a safe haven, it is a volatile asset, and actually almost as volatile as stocks. Another issue is that, given the fact that we’ve already had this big runup in gold, it’s probably not the best time to be buying in right now.

Then another issue to keep in mind is gold is really not a growth asset, long term. It does have a very long record of holding its value over even century-long periods, but it doesn’t really generate growth. So, if you do want to buy gold, I would definitely keep your position size small relative to the rest of your portfolio.

Why It’s Better to Own Large Companies During an Economic Slowdown

Hampton: There have been mixed results on whether large or small is better to own during an economic slowdown. What does history tell us?

Arnott: From a size perspective, large companies typically will hold up better in a recession, and that’s because a larger company usually has more diversified business lines, usually has a stronger balance sheet, so they’re able to better hold up during periods of economic weakness. Whereas smaller-cap companies, they may depend on a single line of business, they may have more debt on their balance sheets. Normally, we see smaller companies tend to fall behind during recessionary periods.

Why Consumer Defensive Stocks Have Been Resilient During Recessions

Hampton: Consumer defensive stocks showed resilience against other sectors during a tariff-induced selloff. Did that hold true in past recessions?

Arnott: Yes. We definitely see a pretty consistent pattern where consumer defensive stocks or consumer staples tend to hold up the best during most recessionary periods. The reason for that is consumers normally don’t change their buying habits that much during a recession. For things that you need on a daily basis like laundry detergent or paper towels, you’re not going to cut back on those things just because the economy is down. Whereas things that are more discretionary, like clothing or cars, that would be probably the first place that people would look when they’re trying to cut back on their spending.

What Sectors Have Been Hit the Hardest in Past Recessions?

Hampton: Which sectors have historically taken the hardest hits?

Arnott: Things like energy, financials, consumer cyclicals, infrastructure-related things, those are all things that tend to be more sensitive to downturns in the economy.

Create an Investment Plan and Stick to It During Market Volatility

Hampton: Market volatility is part of investing. We keep getting the reminders. Explain why it’s important to create the game plan and then stick with it, Amy.

Arnott: I think market volatility can be very unsettling and can make you question about, should I be changing my portfolio? Should I be moving to cash? How can I avoid all of this uncertainty and volatility? But I think it’s always helpful in these times to kind of go back to basics and remind yourself, what am I investing for? What are my long-term goals? Does my portfolio allocation make sense for my time horizon and my risk tolerance?

I think having a plan can really be an anchor against a lot of market uncertainty. There’s a famous quote from John Templeton that I like to go back to, which is “The four most dangerous words in investing are ‘It’s different this time.’” That goes to the idea that every market crisis does feel like it’s different, and there’s always something new that’s causing the volatility and the uncertainty. But the problem is if you start to panic or make dramatic changes to your portfolio in response to that uncertainty and volatility, that can really be counterproductive. So, that’s why it’s helpful to not just have a plan, but stick with the plan.

Hampton: Amy, thank you for your insights. They’re always valuable and for coming to the table today.

Arnott: Thanks. It’s great to be here.

Hampton: That wraps up this week’s episode. Thanks for watching and making this show part of your day. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to senior video producer Jake VanKersen, associate multimedia editor Jessica Bebel, and digital communications specialist Kumudini Devalla. I’m Ivanna Hampton, lead multimedia editor at Morningstar. Take care.