Investing

Defensive Stocks to Buy in a Recession

defensive stocks

Defensive Stocks

It doesn’t look good for markets. Valuations are historically high, earnings are decelerating, and we’re in the midst of a heavyweight fight with the second-largest economy in the world. The resultant uncertainty is creating an appetite for defensive stocks

The one beacon of light is the strength of the U.S. consumer, which is riding a strong labor market and an uptick in wage growth for the first time in several years.

Unemployment is historically low and consumer confidence is high, but many experts fear that the next round of proposed tariffs will finally impact consumers.

Inverted Yield Curve

The bond market raised a big red flag yesterday when the yield curve inverted between the 2-year and 10-year Treasury note.

An inverted yield curve signals a recession is on the horizon. On average, the signal occurs roughly 17 months before the official start of a recession.

It’s still unclear whether the U.S. economy is headed for a recession, but there are definitely warranted concerns regarding both the domestic and global economy.

Recessions are tough times for traders, but some stocks tend to perform better than others during a downturn.

Finding The Best Defensive Stocks

Today, we’ll look at stocks from three sectors that are traditionally considered to be ‘recession-resistant’: Discount Retail, Healthcare, and Entertainment.

Consumers are strong but spending would undoubtedly be affected by a recessionary environment.

These sectors are most likely to generate consistent, stable earnings during a recession because consumers generally keep their spending on groceries, healthcare, and entertainment relatively consistent.

These defensive stocks are a good place to start if you’re looking for a little insurance against a slowdown. 

Top-5 Defensive Stocks

Dollar Tree (DLTR)

Discount Retail

Dollar Tree is a discount retailer that sells off-brand and discounted merchandise. The stock was on fire for most of 2019 but suffered a 17% pull-back this month. A note from Deutsche Bank predicted the tariffs would squeeze the business, but not everyone agrees. CNBC’s Jim Cramer says Dollar Tree has “far less China exposure than one would believe and therefore is not subject to the margin squeeze everyone keeps fretting about come September 1.” 

I think this chain has a lot of value, especially in a recession. From a psychological standpoint, people flock to stocks like this during an economic slowdown. Valuations are reasonable, DLTR is currently trading for less than one times sales and its P/B is a scant 3.85. The recent pullback could be a buying opportunity for investors with a longer outlook.

Costco Wholesale (COST)

Consumer Staples Retail

Costco is not a traditional discount retailer, it’s a warehouse store with a membership-based business model. However, with over 44.6 million paid members with a renewal rate over 90%, they have a myriad of loyal shoppers.

Goods are cheap at Costco, the company’s business model relies on high volume and low margins to generate earnings, and the membership fees are the icing on the cake. Plus, over 30% of Costco’s warehouses are in international markets so it had diversified geographic exposure. Despite the trade war, the Chinese consumer is strong, so Costco’s presence in China could prove to be a big asset if the U.S. economy takes a downturn.

I’m a Costco member and I love this store. Their goods are dirt cheap and buying bulk is a great way for shoppers to save a few bucks. Since I got my membership, I find myself buying more and more of my groceries from Costco, and I don’t think my experience is unique. Costco stores are clean, the staff is friendly, and it’s like a 5-star resort compared to our local Wal-Mart. I think Costco will perform well during a slowdown. 

United Health (UNH)

Healthcare

No matter how bad the economy is, people still need health insurance. United Health is the largest health insurance payers in the United States. The firm has a market cap of over $229 billion and generated $12.99 billion in income last year. With that much cash flow, United is well equipped to ride out a recession. Healthcare has performed poorly in 2019, weighed down by escalating rhetoric from Democrats pushing for healthcare reform, but the downturn could be a buying opportunity.

United is one of the leading companies in healthcare, and it’s trading for cheap after performing poorly for most of the first half of 2019. Unfortunately, the political climate is generating a lot of uncertainty for United and the stock is subject to significant headline risk moving forward. If a Democrat candidate pushing hard for healthcare reform begins to take the lead in the polls, it could have a dramatic effect on the stock. 

CVS Corp. (CVS)

Retail / Healthcare

This stock combines the retail and healthcare sectors in one great company. CVS has the largest retail pharmacy network in the U.S., and the company officially entered the insurance business with the completion of its Aetna Health acquisition in late 2018.

The stock got hit earlier this year when CVS reported difficulties with its Aetna acquisition, but many experts believe that the Aetna deal will start paying dividends for CVS soon. Morningstar says, “The firm’s combination with Aetna should put the company in a much more attractive competitive position as the industry moves toward preferring a more integrated service offering.”

The market is in wait-and-see mode on CVS. Investors want to see results from the Aetna acquisition before they start buying. However, things could already be turning around. Shares of CVS are up over 10% from its bottom in May. 

This is a quality company with a track record for execution. Valuations are excellent, the stock is trading for only 8.15 times forward earnings. If you think the Aetna acquisition is about to turn a corner, getting in now could amount to significant additional gains. 

Disney (DIS)

Entertainment

Disney has been in the news a lot lately in relation to their new streaming service. Disney+ launches this November and it’s cheap. Subscribers can get Hulu (with commercials), ESPN+, and Disney+ for only $12.99; and Disney+ by itself is only $6.99 per month. Netflix starts at $8.99 but its standard package is $10.99.

The streaming business will allow Disney to monetize its MASSIVE content portfolio, which includes the Marvel Universe, Star Wars, and flagship Disney franchises. In addition to streaming, Disney is dominating the box office this year. According to the Observer, Disney films account for 36.9% of domestic box office market share.

Disney performed strongly in 2019, but shareholders got hammered in early August when the company released disappointing quarterly earnings. Disney missed consensus earnings estimates by over $1 billion. That’s not a small miss, but most of the poor performance can be attributed to costs associated with its Fox acquisition and a weak opening in its new Star Wars-themed amusement park.

The pullback improved valuations significantly. Shares are currently trading for only 17 times earnings. I anticipate Disney+ will succeed and, eventually, have a positive effect on share prices.

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