Recessions are hard on everyone – aren't they? Actually, just as wars have their war babies (companies that perform well during war and suffer during peace), recessions have their tough offspring as well. In this article we'll take a look at the industries that flourish in the adversity of a recession and why they do so well when everyone else is struggling to make ends meet.
It makes sense that as budgets feel the strain of an economic downturn, people turn to the stores that offer the most for the least. Discount retailers like Wal-Mart (NYSE:WMT) do well at any time, but this is not entirely true. They often suffer in good times as people flush with money buy higher-quality goods at competing outlets. To remain competitive, they are forced to upgrade their product lines and change the focus of their business from thrift to quality. Their profits suffer from either lost sales or less margin on the goods they sell.
In hard times, however, these retailers excel by going back to core products and using vast economies of scale to give cheap goods to consumers. Designers and producers of lower-end products also see an upswing as more people jump from brand names to make their paychecks go further. People may not like discount retailers, but in a recession most people end up shopping there.
In bad times, the bad do well. Although it seems a little counterintuitive, people patronize the sin industries more during a recession. In good times, these same people might have bought new shoes, a new stereo or other, bigger-ticket items. In bad times, the desire for comforts doesn't leave, it simply scales down. People will pass on the stereo, but a nightly glass of wine, a pack of cigarettes or a chocolate bar are small expenditures that help hold back the general malaise that comes with being tight on cash.
Be warned, though – not all sin businesses prosper in a recession. Gambling, with the exception of the truly troubled gamblers, becomes an extravagance and generally declines during recessions. In fact, casinos do their best trade when the economy is roaring and everyone feels lucky. The most prosperous businesses in this industry are the purveyors of small pleasures that can be bought at a gas station or convenience store.
Expect a downturn in the service industry, as companies and families are willing to take on more work to save money. A certain class of service providers will see an upswing during hard times though. Companies that specialize in upgrading and maintaining existing equipment and products thrive as more clients focus on working with what they have rather than buying something new.
In the real estate industry, they say renovators hire as builders fire, and this holds true for many other industries as well.
In a recession, simply carrying on with business as usual can be an achievement. Pharmaceuticals, healthcare companies, tax service companies, gravediggers, waste disposal companies and many others are in a category that, while not jumping ahead during a recession, can plod along while other companies suffer. This is simply because people get sick, get taxed and die (not always in that order) no matter what the state of the economy. Sometimes the most boring businesses offer the most consistent, but in context, exciting returns.
The Benefits Of Recession
The biggest benefit of hard times is that companies get hurt for inefficiencies that they laughed off in better times. A recession means general fat trimming for companies, from which they should emerge stronger, and that's good news for investors.
One of the best signs is a company in a hard-hit industry that is expanding anyway. For example, McDonald's (NYSE:MCD) continued to grow in the 1970s downturn even though restaurants generally suffered as people cooked rather than going out to eat. Similarly, Toyota (NYSE:TM) was opening new American plants in the 1990s downturn when the Big Three were closing theirs due to falling sales for new cars.
A recession can be a blessing for investors, as it is much easier to spot a strong company without the white noise of a strong economy.
Waiting It Out
Although it is good to know which companies excel in a recession, investing according to economic cycles can be difficult. If you do invest this way, be ready to readjust your portfolio before the economy rebounds, as it will stem the advances the recession-proof industries have made.
Some of the companies performing well in a recession will also perform well in a recovery; others will change their business to take advantage of the upturn. Yet, many will be passed by their toughened-up brethren that race ahead in bull markets – financials, technology firms and other faster-moving industries. With the proper timing, however, these industries can provide a buffer within your portfolio while you wait for your high fliers to take off again.