Can You Recession-Proof Your Portfolio?

Key Takeaways

• There is no uniformly agreed-upon definition for a recession, but the commonly agreed-upon definition is negative gross domestic product growth that lasts two successive quarters.
• There have been some recessions where stocks have done all right, but I think it’s a worrisome trend of stocks falling during a recession, and so I probably wouldn’t want to come into a recession with an all-equity portfolio, especially if I were getting close to retirement.
• Healthcare, utilities staples, and consumer stocks typically perform best during economic weakness. At the negative side of the ledger would be consumer discretionary stocks, industrial companies, and basic materials, and certain parts of the technology sector that do not perform well.
• Global diversification does not provide as much of a benefit as you might think because you tend to see non-US markets moving in sympathy with the US when the US is really in the dumps.
• In eight recessionary periods, high-quality were in the black during recession, so investors should take to heart when building their portfolios.
• You want to look at your portfolio’s component of safer assets, and that’s particularly important if you are someone who is moving into retirement.

Margaret Giles: Hi. I’m Margaret Giles from Morningstar. Amid slowing GDP growth and concerns that tariffs could begin to affect consumer spending, some economists see a higher risk of recession for the US economy than they did at the beginning of the year. Joining me to discuss how investors can recession-proof their portfolios is Christine Benz. She’s Morningstar’s director of personal finance and retirement planning. Christine, thanks for being here.

Christine Benz: Margaret, it’s great to see you.

What Is the Definition of a Recession?

Giles: So first, how do economist define a recession?

Benz: Well, there is no uniformly agreed-upon definition. The National Bureau of Economic Research calls it a significant decline in economic activity that’s spread throughout the economy and lasts more than several months. But the commonly agreed-upon definition is negative gross domestic product growth that lasts two successive quarters. And so definitionally, we don’t know when a recession has begun. We won’t know until we have come through a couple of quarters of negative economic growth.

Giles: Right, so it’s a retroactive declaration.

Benz: Exactly.

Do Stock Always Fall During a Recession?

Giles: OK. So how do stocks play into this? Do stocks always sink during a recession?

Benz: This is something that we looked at in our Diversification Landscape report, which is something that I work on with a couple of our colleagues every year, and we examined specifically periods of recession historically, so we looked at eight particular periods dating back to 1929, and in five of those eight periods, we did see stocks decline during those periods. So I would say that’s enough of a pattern where I would want to take that to heart in terms of assembling my portfolio. It’s not foolproof. There have been some recessions where stocks have done all right, but I think it’s a worrisome trend, and so I probably wouldn’t want to come into a recession with an all-equity portfolio, especially if I were getting close to retirement.

Best-Performing Stocks During Economic Weakness

Giles: So which types of stocks tend to perform the best during those periods of economic weakness? And on a flip side, which tend to post the biggest losses?

Benz: So on the positive side of the ledger would be companies that make products that people will buy regardless of what’s going on in the broad economy, so healthcare stocks are typically at the top of the list where people may curtail their healthcare spending a little bit, but they probably won’t not go to the doctor if they really need to. They’ll continue to buy drugs that they need to take. So healthcare stocks have usually been relatively impervious. Consumer staples stocks as well, companies that make products like paper towels and diapers, you may switch to a lower-cost brand of those things, but you won’t cut them out of your budget entirely. And then finally, utilities would also fit into the category of the types of companies that would perform well in a recessionary environment for kind of the same line of thinking—that you are still going to use water, you’re still going to turn your power on regardless of what’s going on in the economy.

At the negative side of the ledger would be consumer discretionary stocks, so retail stocks, especially retailers of products that are discretionary. Leisure stocks would also tend to fall into this category. People often cut back on travel spending, going out to restaurants during periods of recession. Industrial companies and basic materials companies that tend to be very leveraged to the cycles of the economy will also tend to perform poorly in recessionary environments. And finally, there are certain parts of the technology sector that do not perform well, some of the semiconductor manufacturers, for example. So even though tech as a group might have some defensive characteristics, there are some subsectors that won’t perform especially well.

Does Global Diversification Help During a Recession?

Giles: So does global diversification provide any kind of benefit during those periods of economic weakness?

Benz: Not as much as you might think. The saying goes that when the US sneezes, the rest of the world catches a cold, and I think there’s some truth to that when you look at the data, that you tend to see non-US markets moving in sympathy with the US when the US is really in the dumps. And then the other thing is that there are some shocks, the pandemic is a really great recent example, that are global in nature, and so the US did have a brief recessionary period during the covid pandemic period, and many non-US markets did as well.

Will High-Quality Bonds Stay Positive During Times of Economic Decline?

Giles: So in the diversification research, work you did with Amy Arnott, you found that high-quality bonds have been consistently positive during those periods of decline. Why is that, and do you think that trend will persist going forward?

Benz: We examined those eight recessionary periods historically, and here is a really kind of foolproof dynamic, which is that in recessionary environments, high-quality bonds have been a good place to be, so in eight of those eight periods, they were in the black during recession, so I do think that that’s something that investors should take to heart when building their portfolios. And the reason that we see high-quality bonds perform well during those periods is twofold really. One is that recessions are often kind of a flight to quality, a flight to safety, and typically, US Treasury bonds will perform really well in a period like that. And the other benevolent force working on behalf of high-quality bonds during recessionary periods is that the Federal Reserve is often trying to improve economic conditions by lowering interest rates, and that is another benevolent force for fixed-income investors. While your yields drop, your bond prices increase.

Nonportfolio Assets to Evaluate During Times of Economic Downturn

Giles: So you also think, and to wrap up here, that investors should look at nonportfolio elements, so the rest of their plan. What should they have in mind?

Benz: So you want to look at your portfolio’s component of safer assets, and that’s particularly important if you are someone who is moving into retirement, but for all of us working people and nonworking people, I like the idea of having an emergency cushion set aside, and that’s particularly important if we’re feeling nervous about the prospect of job loss, and I don’t want to scare people. I don’t think we’ve seen any data to suggest that job losses are about to become widespread, but I do think it makes sense to check your liquid reserves and then also check your next-line reserves in your plan. So for a lot of homeowners, that is a home equity line of credit. Securing that while you’re employed I think is a really great practice that you would have that kind of on standby, and the benefit of that is that if you find yourself in need of extra funds, it will keep you from having to resort to unattractive forms of credit, like credit cards or having to sell depreciated equity assets in some sort of a market downturn.

Giles: Certainly good steps to think about. Christine, thanks for being here.

Benz: Thank you so much, Margaret.

Giles: I’m Margaret Giles with Morningstar. Thanks for watching.

Watch The Biggest Risk Investors Face Today for more from Christine Benz.