The economy isn't recession-proof. It often follows a somewhat predictable, if irregular, pattern known as the economic cycle. Periods of expansion can often last for years before hitting a peak. What follows is a period of contraction -- a recession -- before the economy enters a trough ahead of the next expansion.
Recessionary periods can be brutal for investors. Stock market corrections and bear markets commonly occur during the contraction phase. Cyclical stocks -- companies in industries highly sensitive to the economic cycle -- are often the hardest hit during a recession.
However, some stock market sectors are relatively immune to the ups and downs of the economic cycle. They offer investors somewhat recession-proof stocks that they can hold when economic turbulence arises. That's evidenced by the fact that many companies in these sectors have increased their dividends every year for the past few decades, which included several notable recessions. Here's a closer look at where to invest if you're worried that the economy is about to hit a rough patch.
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Diversified portfolios better withstand recessions
Recessions are inevitable, so investors should construct truly diversified portfolios to weather downturns. The key to creating a diversified portfolio is investing in companies across multiple sectors, including recession-resistant ones.
Any diversified portfolio should include a mix of financially strong blue chip stocks with the financial fortitude to withstand a recession. Blue chip stocks are attractive to investors during recessions because they typically pay dividends, providing them with a tangible return in the form of income. Blue chip stocks in recession-resistant industries tend to be especially stable, which can help lessen the blow of a market sell-off from a recession.
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Add some recession-proof businesses to your portfolio
The hottest stocks in recent years have been in the technology and communications industries. Many investors found it easy to build a portfolio that skewed toward these growth-focused sectors by buying stocks related to megatrends such as 5G, streaming services, cloud computing, social media, and artificial intelligence (AI).
Unfortunately, these sectors are not immune to a recession. An economic slowdown could cause businesses to reduce capital spending, which might cause them to cut back on expensive upgrades to 5G or cloud computing. Companies also tend to pull back on advertising during recessions, hurting ad-driven sectors such as social media and some streaming services. As previously noted, consumers tend to eliminate extra costs during recessions, which can affect streaming services and other entertainment options.
That's why it's important to diversify your portfolio to better withstand a recession by adding some defensive or countercyclical stocks in the consumer staples, utilities, bargain retailing, and healthcare industries. Doing so can help your portfolio blunt some of the potential negative impacts of a recession.
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