In a previous article, we discussed the growing risk of a looming recession, a risk that is heightened by stretched asset valuations, the Ukraine crisis, and the ongoing Covid-19 pandemic. We highlighted a flattening yield curve, runaway inflation, and slowing housing market as some of the bearish indicators that investors should keep an eye on.
Here we list several defensive stocks that are likely to withstand a recession with minimal capital erosion. These recession-resistant stocks tend to provide stable earnings and dividends regardless of the state of the overall stock market, and also tend to outperform in bear markets.
Defensive stocks come with a caveat, though: they tend to lag cyclical stocks during strong bull markets. It is therefore prudent to balance your portfolio by having a healthy mix from both baskets.
#1. Walmart
Giant discount retailer Walmart Inc. (NYSE:WMT) has frequently thrived during economic downturns. CFRA Research analyst says investors don't fully appreciate the breadth and depth of Walmart's investments in omnichannel sales initiatives, alternative profit sources, supply chain improvements, and product mix expansion.
For instance, Walmart is expected to invest $16 billion to $17 billion in capital expenditures in 2022, with those e-commerce, technology, and automation investments likely to pay off for long-term investors. With inflation levels at 40-year highs, shoppers are likely to become more price-conscious this year, and increasingly turn to discount retailers such as Walmart.
#2. Costco
Costco Wholesale Corp. (NASDAQ:COST) is a leading warehouse retailer whose business model makes it one of the best retail stocks to own for the long haul. Costco has about 112 million members, of which 62 million are executive members.
Last year, Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) vice-chairman Charlie Munger told investors that Costco held a specific advantage over Amazon Inc. (NASDAQ:AMZN) when it comes to growing its business.
"Costco, I do think, has one thing that Amazon does not. People really trust Costco to be delivering enormous values.That is why Costco presents some danger to Amazon — because they've got a better reputation for providing value than practically anybody including Amazon," Munger said.
Costco is relentless when it comes to pushing to get the best prices possible from its suppliers, not to make more money but rather to get the best possible prices for its customers. This results in a high trust score with its members and allows it to make the bulk of its profits from its satisfied members' annual membership fees.
#3. Lockheed Martin
Lockheed Martin (NYSE:LMT)is a leading defense contractor that produces high-tech weapons and defense systems. LMT also provides a wide variety of services for governments all over the world.
Government budgets and defense spending tend to be much less volatile than other parts of the economy. And the general trend is up: according to the Deloitte Research Center for Energy & Industrials, defense spending, on a global level, is expected to grow at about a 3% average annual rate through 2023 to reach $2.1 trillion.
LMT has a healthy balance sheet and a long history of paying and raising dividends. As an example, Lockheed Martin hiked its quarterly dividend by 7.7% in late 2021 to $2.80 per share, with the current 2.9% yield much higher than the S&P 500's yield of 1.4%.
Further, the company has been moving into higher-growth and -margin segments such as cybersecurity and IT services. LMT's defensive qualities are clearly evident in the current market downturn: LMT shares have returned 23.4% YTD vs. -3.4% by the S&P 500.
#4. Northrop Grumman
Another giant defense contractor, Northrop Grumman Corp.(NYSE:NOC) is another top defensive stock. Over the past five years, NOC has grown its revenue at 8.5% CAGR, earnings 20.3%, free cash flow 8.8%, and dividends 11.8%. This is because defense spending continues to grow on an aggregate level, and NOC is one of the premier stocks in the sector.
In addition to its relative stability as a defense stock, NOC does offer extra growth runways thanks to its exposure to the space industry. Northrop's customers include NASA and telecommunications companies, as it provides services related to space logistics, satellite launches and maintenance, space security, and propulsion systems. Overall, revenue from the space industry is expected to reach $1 trillion by 2040 from its current $350 billion, according to Morgan Stanley.
#5. The Utilities Select Sector ETF
The Utilities Select Sector SPDR ETF (NYSEARCA:XLU) is an exchange traded fund that invests in stocks of companies operating across utilities sectors.
For decades, utility stocks have been regarded as an indispensable part of an income investor's portfolio, thanks in large part to their defensive qualities. First off, utilities tend to be more resistant to economic cycles than most other sectors of the economy because demand for utility services tends to be stable. Utility stocks--such as electric, gas, and water companies--can help stabilize a portfolio by lowering volatility and risk, thanks to the fact that the sector is heavily regulated. Indeed, most utilities have predictable cash flows, which enables many to pay decent dividends with higher yields than other fixed-income investments.
XLU boasts $14.8B in assets under management (AUM) and a 2.72% dividend yield. It's top five holdings are:
- NextEra Energy Inc. (NYSE:NEE)
- Duke Energy (NYSE:DUK)
- Southern Co (NYSE:SO)
- Dominion Energy (NYSE:D)
- Sempra Energy (NYSE:SRA)
