What Is Recession Proof?
Recession proof is a term used to describe an asset, company, industry or other entity that is believed to be economically resistant to the effects of a recession. Recession-proof stocks are added to investment portfolios to safeguard them against times of economic decline, which may be the onset of a recession. Securities that are believed to be recession proof often have negative beta values (such as gold), which would indicate an inverse relationship to the broader market.
Key Takeaways
- Recession proof refers to assets, companies, industries, or other entities that do not decline in value during a recession or decline less than the broader market.
- Examples of recession-proof assets include cash and cash-equivalent investments, such as 3-month U.S. Treasury bills, while examples of recession-proof industries are consumer staples, utilities, and healthcare, among others.
- The term is a relative one since an extended recession can cause a dent in returns even for the most recession-proof assets or businesses.
Understanding Recession Proof
Although many items have been labeled as recession proof, very few turn out to be so. Quite often, the long-reaching consequences of a recessionary period are too much for even the most recession-proof businesses or assets to withstand. Even equities, which are supposedly the most sensitive assets during a recession, are not always predictable. Several recessions (1945, 1949, and 1980, among others) saw price increases for the .
Negative Beta
Securities that are believed to be recession proof often have negative beta values, which indicate an inverse relationship to the greater market. (When the market goes down, the stock goes up, and vice versa.) It was once believed that gold and gold stocks, for example, were recession proof due to gold's negative beta value. Physical gold has performed well in some economic downturns, but this generally occurs under specific circ*mstances such as expected high inflation. Securitized gold (gold shares and exchange-traded funds) tend to have a positive beta. Also, holding assets with negative beta during non-recessionary times reduces the expected return of the portfolio.
An asset with a negative beta has an expected return below the risk-free rate during normal times. Recession-proof investments often underperform during normal times, as well as during the recovery period following a recession.
Defensive Industries
Defensive stocks, like shares of healthcare or utilities companies, are often cited as recession-proof investments. This is because consumers still need to purchase medical care and electricity, regardless of the economic situation. Many defensive industries represent a small percentage of consumer spending, however, limiting their recession-proofing value.
Recession-Proofing an Overall Portfolio
Several factors can be used to safeguard an overall portfolio against a recession, including asset diversification, rebalancing, and a long investment timeline. Increasing the amount of cash holdings in a portfolio is also a good way to protect it against a recession, at the opportunity cost of forgone returns. This enables investors to access liquidity quickly to take advantage of a falling stock market. Cash benefits from deflation in a recessionary environment, as the purchasing power of each dollar rises. U.S. Treasury Bonds are considered recession proof because they are backed by the government of the world's biggest economy.
Example of Recession-Proof Assets
In the stock market, several companies and sectors are considered recession proof because they can buck the downward slide of the market or have a relatively lower percentage decline compared with other sectors or indices.
An example of the former is retailing behemoth Walmart Inc. (WMT). The Arkansas-based giant reported growth in profits and revenues in the three years following the Great Recession. Consumers cut back on their spending and shopped at discount retailers, who upped their game by using their economies of scale to drive lower prices for products.
Utility stocks are an example of the latter. The reasoning for considering utilities a safe bet during a recession is that people will still need to pay their water and electric bills during a recession. Investors and traders are often less interested in utility stocks because they are less volatile as compared to the rest of the market and offer fewer chances for making money in a short time. However, utilities are among the couple of sectors where it is possible to park money safely during a recession. While other sectors could dip into negative territory or fall by double-digit figures in a recession, utility stocks may remain relatively stable.
What Are the Most Recession-Proof Stock Sectors?
Among the Global Industry Classification Standard (GICS) 11 stock sectors, consumer staples, utilities, healthcare, and energy are among the most recession resistant. That is because they are always in demand regardless of the state of the business cycle. While they may not see actual appreciation during a recession, they are likely to see smaller declines than the market as a whole.
How Do I Insulate My Portfolio From Recessionary Periods?
Stocks are typically the largest allocation of a portfolio, with fixed income (bonds) making up the rest. There is no set formula to avoid declines in stock holdings, except to move your stock allocation into cash or cash equivalents, e.g., short-term (3-month) U.S. Treasury notes. In such a reallocation, you're effectively pulling out of the stock market for a certain time period, which means you are more likely to miss the rebound once the recession is over or on the wane.
Should you wish to keep your overall stock allocation the same, a process known as sector rotation could be employed. Sector rotation basically involves moving from growth stocks to defensive stocks, such as moving from tech stocks to utilities. While it's not guaranteed to make you more money, it is intended to reduce your relative loss. It will also keep you invested in the market, so you don't have to worry as much about picking the bottom and then re-investing.
Should I Keep My Stock Holdings During a Recession or Dump Them Entirely?
That depends on your risk tolerance and, more importantly, your investing time horizon. If you have a long investing time horizon (10+ years), meaning you won't need the money anytime soon, you are probably better off maintaining your stock exposure during a recession. If you feel compelled to make changes in your portfolio, you can look to reposition your stock holdings out of growth sectors and into defensive sectors. While it may seem painful at first, you eliminate the risk of missing the bottom and failing to participate in the subsequent economic recovery and rebound in markets.
The Bottom Line
It is the rare exception for a stock to rally substantially during an economic recession when the rest of the market is taking a nosedive. If a stock does break the pattern and rise in a falling market, it is most likely due to a stock-specific factor, such as a merger or an increase in the stock's dividend, for example. In that sense, recession proof is more of a misnomer than a real market descriptor. Recession resilient is probably more apt.
Still, if you're intent on maintaining your allocation to stocks, you would do well to consider sector rotation, where you move your holdings out of more volatile growth stocks and into less volatile defensive, dividend-paying stocks such as utilities, consumer staples, and healthcare. These sectors have the best opportunity to hold steady and possibly advance, depending on the severity of the recession at hand.
If you're more flexible in your asset allocation, you might consider increasing exposure to bonds (bond prices rise as interest rates typically fall during a recession) and dividend-paying stocks as fallback investment vehicles.
