Firstly, What is a Recession?
A recession is a period of economic decline, characterized by reduced economic activity, declining GDP (gross domestic product), high unemployment, and other negative economic indicators. It is typically defined as two consecutive quarters of economic contraction, or negative growth. During a recession, businesses may struggle and consumer spending may decrease, leading to a decline in corporate profits and stock prices. Governments may implement fiscal and monetary policies to try to stimulate economic growth and reduce the severity of a recession.
According to Raghuram Rajan, a former governor of India’s central bank and ex-chief economist at the International Monetary Fund, the US economy may experience a small economic contraction if the financial sector is able to avoid issues as the Federal Reserve raises rates to stem inflation. Rajan stated that if there are no financial sector problems, it could still be a mild recession, but there is the potential for things to build on each other, such as employers waiting to lay off workers and triggering a sharper downturn. He also raised the question of whether the Fed will be able to fine-tune things to prevent a potential downturn. The Fed has raised its benchmark interest rate from almost zero in March to 4.3% by December, the highest level since 2007, in an effort to stem an inflation rate that rose to the highest levels in four decades earlier in 2022 and has yet to return to the central bank’s 2% goal. Central banks globally have been tightening policy to prevent further price growth, which has cooled economic activity in the process. The IMF estimates that about one-third of the world economy will experience at least two consecutive quarters of contraction this year and next, resulting in $4 trillion of lost output through 2026. Rajan also noted that by 2025, the world will be facing the problem of very slow growth due to weakness in emerging markets, low immigration, and a slowdown in Chinese expansion relative to its historical rates.
Best Type of Stocks for a Recession:
During a recession, it is generally recommended to diversify one’s portfolio and consider adding assets that may hold up better during economic downturns. Some types of stocks that may be less affected by a recession include:
- Defensive stocks: These are companies that provide essential products or services that are in relatively consistent demand regardless of economic conditions. Examples include utilities, healthcare, and consumer staples.
- Dividend-paying stocks: Companies that pay dividends may provide a steady stream of income for investors during a recession.
- Blue-chip stocks: Large, well-established companies with strong financials and a history of stability may be less impacted by a recession than smaller, more vulnerable firms.
- Treasury bonds: Government bonds, particularly those issued by the US Treasury, are considered a safe haven asset and may be less affected by economic downturns.
Best ETFs For the Recession:
The Consumer Staples Select Sector SPDR ETF (XLP) is an exchange-traded fund (ETF) that tracks the performance of the Consumer Staples Select Sector Index. It is a passively-managed fund that aims to replicate the performance of the index. As of December 31, 2020, it had total assets of $13.5 billion and an expense ratio of 0.13%. Its top three holdings are The Procter & Gamble Co., The Coca-Cola Co., and PepsiCo Inc. XLP has a dividend yield of 2.45%.
The iShares US Healthcare Providers ETF (IHF) is an ETF that tracks the performance of the Dow Jones U.S. Select Health Care Providers Index. It has total assets of $1.1 billion, an expense ratio of 0.42%, and an average daily volume of 110,000. Its top three holdings are UnitedHealth Group Inc., CVS Health Corp., and Cigna Corp. IHF has a dividend yield of 0.62%.
The Vanguard Dividend Appreciation ETF (VIG) is an ETF that tracks the performance of the NASDAQ US Dividend Achievers Select Index. It has total assets of $53 billion, an expense ratio of 0.06%, and an average daily volume of 2.4 million. Its top three holdings are Microsoft Corp., Visa Inc., and The Procter & Gamble Co. VIG has a dividend yield of 1.61%.
The Utilities Select Sector SPDR ETF (XLU) is an ETF that tracks the performance of the Utilities Select Sector Index. It has total assets of $11.8 billion, an expense ratio of 0.13%, and an average daily volume of 23.4 million. Its top three holdings are NextEra Energy Inc., Dominion Energy, and Duke Energy Corp. XLU has a dividend yield of 3.1%.
The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) is an ETF that tracks the performance of the iBoxx $ Liquid Investment Grade Index. It has total assets of $27.2 billion, an expense ratio of 0.15%, and an average daily volume of 2.6 million. Its top three holdings are Exxon Mobil Corp., Apple Inc., and Verizon Communications Inc. LQD has a dividend yield of 2.47%.