From the pundits to the analysts to the economists, most experts now think there is a strong likelihood of a recession later this year or in early 2023. As the calls grow louder, it's not a bad idea to buy some stocks that can withstand and perform better in a tougher economic environment.
One area to look at is bank and financial stocks, many of which benefit from rising interest rates. However, the key is to find ones that are also more insulated against a recession, which includes declining economic growth and therefore less spending and investing by businesses and consumers.
The Federal Reserve each year places the largest and most important banks and financial companies in the U.S. through a hypothetical severe recession-like scenario to see how these companies would hold up during an intense economic shock. This year, the Fed's hypothetical scenario included unemployment surpassing 10% sometime between the fourth quarter of 2021 and the first quarter of 2024. Stock prices would fall 55%, and commercial real estate prices would dip 40%.
Using the results from the Fed's stress testing, as well as other information, here are two great financial stocks to buy as the economy braces for a recession.
1. Charles Schwab
The large custody, asset and wealth management firm Charles Schwab (SCHW 0.89%) has $7.3 trillion of client assets.
With much less of a focus on lending, the company is less prone to take loan losses in a severe recession. Furthermore, in a recent research note, Brennan Hawken, an analyst with UBS, stated that the company is less susceptible to market and credit risk than its peers.
The Fed's stress testing confirmed this with Schwab only taking $1.2 billion of loan losses over the nine-quarter hypothetical scenario, which equates to just 1% of its total loan book. That is practically nothing when you look at just how severe the scenario is. Other large banks and financial companies in Fed stress testing would take tens of billions of loan losses.
Furthermore, the Fed's stress testing showed that Schwab would generate a roughly $7 billion pretax profit over the nine-quarter stressed situation, which is more than any of the 33 banks tested by the Fed.
The great thing about Schwab is that it is also heavily tethered to a rising interest rate environment. At the end of the first quarter of 2022, the company said that a 1% increase in the Fed's overnight benchmark lending rate, the federal funds rate, would boost net interest revenue by 12% over a year's time. The Fed has already increased the federal funds rate by more than 1.5 percentage points this year, with more rate hikes expected.
2. American Express
A credit card company might seem counterintuitive heading into a recession because credit card defaults typically rise when the economy tightens. However, the Fed's stress testing showed that American Express (AXP 1.32%) would perform extremely well during an economic downturn.
In the Fed's scenario, AmEx would take $14 billion of loan losses over the nine-quarter period, which is equivalent to 9.6% of its total loan portfolio. That's a big hit, as to be expected with a credit card company, but AmEx would also generate a pretax profit of $5.1 billion during the period, which is quite impressive.
AmEx has one of the most reputable brands in the credit card industry, which allows it to charge high subscription fees on several of its cards. The company also has created a closed-loop payments network that earns it lots of fee revenue on transactions it facilitates between merchants that accept AmEx cards and card users. So, as purchases get more expensive, AmEx collects higher fees.
A recession could certainly slow consumer spending, but many AmEx customers are prime and super-prime borrowers and therefore are more resilient under difficult economic conditions.
