Stocks to buy

How to Navigate Recession Threats

Everybody is worried about the “R” word: recession.

Nobody likes them. It’s much easier to invest in the stock market when the U.S. economy is expanding because most stocks go up during economic expansions. As the old saying goes, “A rising tide floats all boats.”

Unfortunately, when the U.S. economy starts to contract and the tide starts falling, not all stocks perform equally. Some sectors tend to outperform while others woefully underperform.

However, the good news for investors during these pullbacks is that the market tends to respond relatively predictably when the pullbacks occur. The same sectors that outperformed during previous economic contractions are likely to outperform during the next.

You can see this illustrated in the sector performance chart below.

Based on sector performance during past economic contractions, we would expect the following sectors to outperform…

  • Energy
  • Healthcare
  • Consumer Staples
  • Utilities

So how have these sectors been performing since Aug. 16 when the S&P 500 reached its most recent peak?


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A Staggering Difference

Looking at a comparison chart of the 11 S&P 500 sectors and the S&P 500 itself (tracked by State Street Global Advisors through their Select Sector SPDR funds), you will see the following performance…

  • Energy Select Sector SPDR® Fund (XLE): 2.30%
  • Health Care Select Sector SPDR® Fund (XLV): -8.19%
  • Consumer Staples Select Sector SPDR® Fund (XLP): -10.44%
  • Financial Select Sector SPDR® Fund (XLF): -14.32%
  • Industrial Select Sector SPDR® Fund (XLI): -14.58%
  • Materials Select Sector SPDR® Fund (XLB): -15.23%
  • SPDR® S&P 500 Fund (SPY): -16.47%
  • Utilities Select Sector SPDR® Fund (XLU): -18.29%
  • Consumer Discretionary Select Sector SPDR® Fund (XLY): -19.05%
  • Communication Services Select Sector SPDR® Fund (XLC): -20.21%
  • Technology Select Sector SPDR® Fund (XLK): -22.88%
  • Real Estate Select Sector SPDR® Fund (XLRE): -25.62%

Nearly all of the sectors you would expect to see outperforming during an economic contraction are currently outperforming. The one exception is the Utilities sector.

Utilities stocks are currently underperforming because the value of the 10-year Treasury Yield (TNX) has risen dramatically during the past few months as the Federal Reserve has aggressively hiked interest rates. The TNX is now threatening to break above 4% (see below).

The higher Treasury yields go, the less competitive dividend yields on Utilities stocks become.

Since strong dividend yields are one of the primary factors that drive the outperformance of Utilities stocks during economic contractions, we are seeing Utilities stocks lagging a bit during this downturn.

The bottom line: We’re watching for Healthcare stocks and Consumer Staples stocks to continue outperforming the rest of the market.

Energy stocks may not perform as well if the price of crude oil continues to bounce down from the down-trending resistance level it hit on Monday.

Right now, sitting on your hands probably feels impossible, but unavoidable.

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Sincerely,

John and Wade

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