There are different reasons to invest in stocks and one of which is to build wealth and outpace inflation. Some also invest in these assets to preserve their wealth. However, while they have advantages, they also have disadvantages and risks.
But not all of them are created equal. There are different types of stocks. Some are categorized according to their market cap while others are grouped according to their alignment with a particular investment strategy or investment goals and objectives.
It is important to underscore the fact that some stocks have an edge over others because they either remain resilient during an economic recession or that they become reasonable investments during a particular economic downturn or when the stock market is volatile.
Maximizing Opportunities During a Recession: Choosing the Right Stocks to Buy During an Economic Downturn
The stock market and stock indices are often out of shape during a recession or an economic downturn. This comes from the fact that some investors become risk-averse and opt to sell stocks and seek safer investment options. Reduced sales and corporate earnings due to the declining purchasing power of consumers and decreasing global trade also impact the stock market.
However, the market is complex and dynamic, and some stocks from certain sectors and industries tend to remain resilient despite a recession. There are also stocks that become ideal investment options during an economic downturn because of their higher potential to appreciate when the economy recovers and enters an expansion phase.
Take note of the following:
1. Defensive Stocks
Remember that some sectors and industries remain stable during a recession. The companies that operate in such are also called recession-proof companies because their earnings are either consistent or even increasing. The stocks that they issue are considered one of the main types of defensive assets and instruments. These are called defensive stocks.
Investing in defensive stocks has notable benefits or advantages due to their unique characteristics. Their stock prices tend to remain stable during economic downturns or when the overall stock market is in a slump. Investing in them can also be part of a defensive investment strategy and also a wealth preservation strategy.
These stocks are found in so-called defensive sectors and industries such as utilities, energy, health care, and consumer staples sectors and industries. Specific examples include providers of essential services such as heating, water, and telecommunication, and upstream to downstream oil and gas companies, and electricity generators and distributors.
Other examples include hospitals, pharmaceutical companies, producers of medical devices, and even health and life insurance companies, as well as manufacturers of bare-bone necessities such as food and beverages, toiletries and personal care products, household goods such as cleaning products, and tobacco and alcohol, among others.
It is important to underscore the fact that the demand for goods and services provided by the companies mentioned above remains essential regardless of the economic condition. Most of their consumers will purchase their products irrespective of the economy. This is the reason why their earnings and overall performance remain stable during a recession.
Nevertheless, considering the aforementioned, it is important to have defensive stocks in an entire stock portfolio to minimize the risks associated with the economic cycle. It is also important to note that these stocks may not perform as well during a period of economic expansion when compared to growth stocks and cyclical stocks.
2. Cyclical Stocks
There are also stocks that become more appealing during a recession. These are called cyclical stocks. They are specifically characterized by their volatile prices that tend to follow the boom and bust cycles of the economy. This means that their value appreciates during an economic expansion and depreciates during an economic recession.
Of course, some might consider these stocks unappealing because the downward trend in their value is more apparent compared to other types of stocks during a recession. Their volatility is one of its main disadvantages. However, the same volatility and poor performance during an economic downturn can also be considered a source of its advantage.
Most cyclical stocks essentially become more affordable during a recession. This comes from the fact that their stock prices plummet when the economy is not doing well because companies that issue them tend to earn less while also cutting back on their spending and expansion. Investing in them is akin to purchasing them at a discounted price.
The specific advantage of purchasing cyclical stocks during a recession is that they have the potential for generating higher gains or more substantial capital appreciation than other types of stocks such as value stocks and defensive stocks once the economy rebounds. Investors and traders can earn once they sell these stocks during economic expansion.
Companies that offer these stocks are in the consumer discretionary sector which includes the automaking and consumer electronics industries, the construction industry, and producers and suppliers of basic materials. They also have a high beta and their historical earnings are tied to the historical performance of the economy.
It is important to note that not all cyclical stocks are suitable investments during a recession because some might not be able to recover. It is critical for an investor to look for the record of performance of prospective companies. The most suitable companies are those with established brands or those with price leadership and other competitive advantages.
3. Cap-Based Stocks
Stocks are also classified according to the size of their issuing companies as determined by their market capitalization. Some of these stocks can provide long-term investment opportunities during a recession because of their potential for higher capital appreciation. Note that these stocks can also be growth, value, defensive, or cyclical stocks.
The specific cap-based classifications of stocks are small-cap stocks which represent startups and small companies with a market cap of between $300 million and $2 billion, mid-cap stocks which are issued by companies valued between $2 billion and $10 billion, and large-cap stocks represent companies with a market cap of $10 billion and more.
Some large-cap stocks are ideal investments during a recession because their prices tend to plummet whenever the economy is in a bad shape. Their prices have the potential to appreciate once the economy recovers. The same is true for some mid-cap stocks. Investing in these stocks during a recession means purchasing them at a discounted rate.
Among the advantages of large-cap stocks include their well-established and proven track record, possible dividend payouts, and a higher degree of liquidity compared to small-cap stocks. Mid-cap stocks have some of these advantages but they also have the advantage of having more growth potential while being less expensive than large-cap stocks.
However, not all large-cap and mid-cap stocks are good investment options during an economic downturn. Some of these stocks might never rebound. Others might take a while to recover. Look for companies with market leadership or those that are in sectors and industries with the highest potential to regain momentum during economic expansion.
Some examples of ideal large-cap and mid-cap companies to invest in during a recession include several tech giants such as Amazon, Apple, Google, and Microsoft, emerging tech companies that are disrupting their respective markets, businesses operating in either defensive or cyclical sectors and industries, and other disruptive companies.
Productive Stock Investing During a Recession: A Note on Stocks to Buy and Keep During an Economic Downturn
There are several notable individuals who have made a fortune from investing in stocks during a recession. Warren Buffet made several investments during the 2007-2008 Financial Crisis which included a USD5 billion investment in Goldman Sachs and USD3 billion in General Electric. His investments generated significant gains after the crisis.
Several companies also performed well during an economic downturn. The stocks of Zoom Video Communication experienced significant capital appreciation during the coronavirus pandemic as people and institutions adopted video conferencing. Amazon was also the biggest winner during the pandemic due to the exponential growth of its stock value.
However, it is important to note that both Zoom Video Communication and Amazon, as well as other companies that benefited during the coronavirus pandemic, have experienced a downward trend in their stock prices. Investors who held these stocks before the pandemic and sold such during the crisis would have generated substantial gains.
Timing is an important factor for succeeding in stock investing during a recession. Defensive stocks would keep an entire portfolio afloat during a downturn while cyclical stocks are ideal for further portfolio diversification. It is better to have defensive stocks during a recession and purchase cyclical stocks and other discounted stocks during a recession.
Having a defensive stocks can be part of wealth preservation strategy during a recession. These are the most recession-proof to invest in. Some stocks such as cyclical stocks, growth stocks, mid-cap stocks, and large-cap stocks are ideal to purchase during a recession because of their low prices and potential for generating higher returns once the economy recovers.