It's been a tough year in the stock market. High inflation has the Federal Reserve raising interest rates at its fastest pace in decades -- affecting every corner of the market.
The Federal Reserve is working to cool down consumer demand in an effort to slow inflation, and that has some CEOs nervous it could trigger a recession. JPMorgan Chase CEO Jamie Dimon warned that the U.S. will fall into recession within six to nine months. In an interview with CNBC, Goldman Sachs CEO David Solomon said, "There's a good chance that we have a recession in the United States."
If a recession is coming, as investors, it would be prudent to have stocks in your portfolio that can weather an economic slowdown.
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What I look for in a recession-proof company is steady customer demand regardless of the broader economy, an ability to cut costs or raise prices without affecting customer count, and an asset-light business. One sector of the market that meets these criteria but is often underappreciated is insurance.
In The Davis Dynasty: Fifty Years of Successful Investing on Wall Street, John Rothchild tells the story of Shelby Davis, one of the best investors many have never heard of. Davis started investing when he was 38 and turned $50,000 into $900 million when he died at the age of 88 -- giving him an average annual return of about 23%. In the book, Rothchild describes why Davis liked insurers so much:
Insurers offered a product that never went out of style. They profited from investing their customers' money. They didn't require expensive factories or research labs. They didn't pollute. They were recession-resistant. During hard times, consumers delayed expensive purchases (houses, cars, appliances, and so on), but they couldn't afford to let their home, auto, and life insurance policies lapse.
For this reason, I think insurance-related businesses can do an excellent job of surviving a downturn in the economy. Progressive (PGR 0.52%), Marsh & McLennan (MMC -0.01%), and Arthur J. Gallagher (AJG 0.43%) have done a solid job riding out inflationary pressures this year. Here's why these three stocks can weather a potential recession.
Demand for auto insurance is never-ending
Progressive writes both auto and homeowners insurance policies. The company is one of the best at writing insurance policies, largely because of its use of driver behavior to calculate the premiums it should charge customers. Progressive was one of the first insurers to use driver behavior, known as telematics, nearly a decade ahead of its competition. As a result, it crushed the industry with its ability to write profitable policies.
The combined ratio shows how well an insurer writes policies and is the ratio of expenses plus claims costs to the total premiums taken in. A ratio under 100% means its policies are profitable, and the lower the percentage, the better. Since 2011, Progressive's combined ratio of 92.7% has crushed the industry average of 100%.
Auto insurance will also see strong demand since it is a requirement for anyone owning a car, which provides Progressive with a steady stream of revenue no matter what the economy is doing.
Strong demand allows Progressive to have flexibility in pricing its policies. It's one reason the insurer has weathered inflationary pressures so well over the past year. This pricing power will be a positive during recessionary times, too.
Progressive could also benefit from the eventual lowering of interest rates. The Fed tends to cut interest rates during recessions to spur the economy and support assets. If inflationary pressures subside due to the recession, the Fed could cut rates.
The reduction of interest rates actually makes Progressive's portfolio more valuable. That's because there is an inverse relationship between interest rates and bond values. This year, Progressive's portfolio is somewhat hurt by rising interest rates. However, if rates are cut during a recession, the insurer will see its portfolio recover, which could boost earnings.
Insurance sales and consulting should also perform well across economic cycles
Marsh & McLennan and Arthur J. Gallagher are similar companies that advise businesses on risk and help them manage that risk by finding the right insurance policies. Together, they are two of the four largest insurance brokers worldwide.
The two brokers saw favorable tailwinds to their businesses this year. For one, rising insurance prices benefited these businesses. That's because they earn commissions based on the total premiums customers pay. When premiums go up, so do their commissions. According to the Marsh Global Insurance Market Index, insurance prices increased 9% from last year, and insurance prices have increased for 19 quarters in a row.
In the past few years, companies dealt with economic uncertainty, supply chain issues, inflation, market volatility, and a green energy transition -- leading to strong demand for their consultation services. Dan Glaser, CEO of Marsh & McLennan, told investors that "when the world is unsettled, demand for our services rises." According to Glaser, the company grew its earnings per share (EPS) during recessionary periods since 1962, making it a solid investment to hold through market cycles.
According to Fitch Ratings, the predictable business model of Arthur J. Gallagher helps it perform well across economic cycles. The rating agency noted that Gallagher saw high client retention and solid organic growth during the great financial crisis from 2008 to 2010.
Marsh & McLennan and Arthur J. Gallagher also have asset-light business models where employee compensation is their most significant expense. For this reason, these companies can ride out recessions and stabilize the bottom line through these cycles.
While insurance-related companies aren't the most exciting investments, their sound businesses and steady demand can help them weather inflationary pressures and recessions -- making them worth considering as a part of your diversified portfolio.
