The U.S. economy officially entered into a recession in February, and challenging conditions will likely continue in the near future. The coronavirus pandemic has presented a variety of obstacles and uncertainties that have shaken confidence at the consumer and enterprise levels and prompted dramatic shifts in business operations.
U.S. gross domestic product (GDP) declined 32.9% on an annualized basis in the second quarter, the biggest drop in the country's history. The economy is expected to improve significantly in Q3 and Q4, but investors should make sure that they are approaching the stock market with the realities of the current recession in mind.
Here are three things to consider as you chart your portfolio strategy during a recession.
1. Each recession is different
If you're managing investments right now, there may be a natural temptation to look at patterns and strategies from prior recessions and attempt to map them on to the current situation. Relying on previously successful playbooks and companies simply won't cut it in many cases. Take a look at The TJX Companies (NYSE:TJX), for example.
I named TJX as a top stock for recession-proofing your portfolio in January, highlighting the company's bargain-focused business and market-beating performance in previous recessions as appealing characteristics. I also cited the company's dividend and its 23-year history of annual payout growth as reasons why the stock could be resilient in a challenging economic environment.
The conditions created by the coronavirus pandemic quickly poked holes in my investing thesis, and the company's shares are significantly underperforming the broader market this year.
What was sturdy yesterday won't necessarily be sturdy today. Over 60 companies in the S&P 500 index have reduced or suspended their dividends this year, including TJX.
Dividend-paying companies and other classes of defensive stocks can still play a foundational role in your portfolio, but finding resilient investments in these categories has taken on new layers of complexity. Brick-and-mortar retail operations are facing a range of new complexities, the utilities sector is lagging the broader market, and energy and commodities prices have been subject to wild swings. Investors should be wary of expecting that stocks and strategies that thrived in previous recessions will necessarily be winners in the current climate.
Many business sectors and industries that were among the most resilient in previous recessions are now among those at high risk for disruption in a fast-changing global economy.
2. Focusing on high-quality companies takes on added importance
The weakened economy and overall uncertainty created by the novel coronavirus pandemic have shifted the operating environment. Recessions can shake out relatively weak businesses or reduce the odds of success for speculative plays that depend on ideal operating conditions to succeed. These dynamics mean that investors have to prioritize strong companies even more than usual.
With stocks still trading at relatively high prices despite the economic challenges at hand, the market is more forward-looking than ever. Individual investors have to do their best to be forward-looking as well. It's important to focus on stocks that are backed by high-quality underlying businesses capable of charting a path to continued success over the long term.
3. Recessions can present opportunities to buy strong businesses
The broader market has come roaring back following the March sell-off spurred by the coronavirus pandemic. However, there are still stocks trading at depressed valuations or that otherwise present attractive long-term growth potential. Additional volatility as the year progresses may create opportunities to build positions in high-quality stocks at attractive prices.
Amazon.com (NASDAQ:AMZN) is up 73% on the year and still has plenty of room for growth over the long term. E-commerce continues to account for a growing percentage of total retail spending, and the company's cloud services business benefits from the increasing importance of digital commerce and communications. E-commerce services provider Shopify (NYSE:SHOP) is also thriving amid this year's unexpected conditions, and its share price has soared more than 170% in 2020. Cybersecurity specialists CrowdStrike (NASDAQ:CRWD) and Cloudflare (NYSE:NET) are up 130% and 149%, respectively, amid accelerated digital transitions for businesses and other institutions.
If you had purchased any of these stocks as the economy entered a recession in February, you'd be sitting on fantastic gains right now. If you had the fortitude to invest in March when the market was crashing, your returns would be even more impressive.
Recessions can lead to big sell-offs and volatile market conditions, but they can also present opportunities. Tough times for the economy and the stock market can be great times to invest -- provided you have the financial security to do so and narrow your search to focus on strong businesses capable of going the distance.