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 greater market.
- Recession-proof refers to assets, companies, industries or other entities that do not decline in value during a recession.
- Examples of recession-proof assets include gold, US Treasury bonds, and cash, while examples of recession-proof industries are alcohol and utilities.
- 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, 1980, among others) saw price increases for the S&P 500.
Securities that are believed to be recession proof often have negative beta values, which indicate an inverse relationship to the greater market. 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 typically under specific circumstances, including 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 stocks, like health care or utilities, are often cited as recession-proof investments. The reasoning being that 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 guard it against a recession, at the opportunity cost of forgone returns. This enables investors to access liquidity quickly in order 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 buck the downward slide of the market or have a relatively lower percentage decline as compared to other sectors or indices.
An example of the former is retailing behemoth Walmart. 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. Typically investors and traders are not 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.
But they are among the couple of sectors to park money safely during a recession. While other sectors dipped into negative territory or fell by double-digit figures, utility stocks remained relatively stable.