When the economy hits a slow patch, seeking shelter in pockets of the stock market where companies can still grow their earnings has long been a go-to investment strategy.
The reason is simple: How much money a company earns is one of the key drivers of stock price performance. So, with the U.S. economy in a recession for the first time since 2009, and the Federal Reserve projecting that the nation’s GDP will decline 6.5% in 2020 and the unemployment rate will end the year at 9.3%, portfolio managers covet growth more than ever.
Indeed, the more insulated a company’s sales and profit streams are from economic woes, the more likely it is that their stock will perform better relative to companies whose profits suffer more during slowdowns.
Growth, it turns out, is good, and is viewed as a type of safety play on Wall Street.
“Safety is viewed through the lens of consistency of earnings growth, and not volatility of earnings,” says Joe Fath, manager of T. Rowe Price Growth Stock fund.
The attributes these types of companies share are similar no matter what type of business or industry they are in.
“What we’re looking for is a company that can grow no matter what,” says Thomas Martin, senior portfolio manager at GLOBALT Investments in Atlanta. “They are in the right spot in their industry versus their competitors. They have a competitive advantage, some sort of lead or moat. They will be taking market share rather than losing share.”
When it comes to generating steady earnings through both good and bad times, some industry groups tend to hold up better than others. Some examples include:
Technology
Tech, known for innovation, productivity-boosting software and must-have apps that transform the way people live, work and communicate, is lauded for its growth characteristics. In the first quarter of 2020, tech stocks in the Standard & Poor’s 500 grew earnings 7%, compared with a drop of nearly 13% for the broad index. In the current quarter, which ends June 30, tech profits are seen declining 8.5%, versus a nearly 43% contraction for the S&P 500.
Companies in the tech space are disruptors and drive societal trends with staying power. They’re at the forefront of long-term shifts, such as the pivot to a digital world, working from home, socializing and newsgathering on smartphones, shopping online, streaming TV content, and storing reams of data in the cloud.
And being at the center of those trends creates demand for their products no matter what the broader economy is doing.
“Tech is the easy place to go or hide out regardless of what’s happening in the economy,” says David Reyes, founder and chief financial architect at Reyes Financial Architecture in San Diego.
He cites a company such as Zoom, a leader in online videoconferencing, a growing trend as the adoption of remote working and online worker collaboration gains a greater foothold in the economy.
“It’s a company that is economically agnostic,” Reyes says. “People will need to communicate via the web regardless of how the economy is doing. It’s a perfect example of a non-cyclical stock, or one that is not reliant on employment or GDP.”
Zoom’s shares, though, already have a lot of good news built into its share price following a spike in usage during the recent economic shutdown.
If there’s a downside to tech now, however, it’s that the group has had a stellar run and many of its popular stocks have had big run-ups, such as Zoom, Tesla and payment giants Visa and MasterCard. That’s why T. Rowe Price’s Fath is recommending tech stocks positioned in fast-growing areas that are selling at more reasonable prices relative to their earnings.
One less well-known play in the mobile pay space, for example, that is benefiting from the long-term shift away from people using paper money is Fiserv (FISV). The stock, which was among the T. Rowe Price Growth Stock fund’s top 20 holdings as of March 31, is trading at a much more reasonable valuation despite being a “very steady grower” and “relatively economically resistant,” Fath says.
Still, many emerging tech trends are just beginning their penetration into markets.
“Is cybersecurity going away? No,” says GLOBALT’s Martin. “Is cloud computing going away? No.”
Communications Services
Since this group of stocks was realigned in 2018, growth names like video streaming service Netflix, search-engine Google’s parent Alphabet and social media giant Facebook are now in the lineup. The good news is stocks like Facebook and Google not only benefit from durable earnings growth but now trade at a reasonable price relative to their earnings, Fath says.
Companies like Netflix, which GLOBALT’s Thomas says are on the “forward-looking side of change”, also tend to grow faster than the overall market during periods of economic softness.
Health care
The need for knee replacements, medical diagnostics and surgeries doesn’t go down just because the economy isn’t firing on all cylinders. Increasingly, health care, too, is being driven by technological breakthroughs and apps that drive growth, Fath says. The use of robotics, for example, is powering the joint replacement surgery business of Stryker (SYK). And so-called telehealth services offered by companies like Teladoc Health (TDOC), which enable patients to consult with their doctors virtually, is also in a growth sweet spot.
“We’re in the early days,” Fath says about virtual medical treatment. “You’ll see more innovation” and greater usage over time.
Utilities
Earnings of companies that provide everyday services like electricity also tend to hold up better when the economy slows, says Reyes, who advises investors to own stocks in sectors that will provide stability in tough times. In the current second quarter, utilities companies in the S&P 500 are expected to see just a 3.3% drop in earnings, vs. a 40%-plus drop for the broader index.
Reyes points out that when economic growth slows, interest rates tend to fall as well. That makes higher-yielding stocks with steady earnings like utilities a good place to park some capital, he says. The current yield on the 10-year Treasury note is around 0.70%, far below the 3.5% average yield of utilities stocks in the S&P 500, according to S&P Dow Jones Indices.
Similarly, companies that sell staples like cereal and toilet tissue, Reyes says, also have historically seen their profits remain firm despite softness in the economy.
Reyes also says that investors should also be on the lookout for an eventual economic upswing. Buying stocks that benefit from a rebounding economy can be profitable if the purchases coincide with stronger growth. His favorite pick is so-called small-cap value stocks, or smaller companies whose shares are undervalued.
“When we come out of recession, typically small-company stocks will outperform,” Reyes says. “Small company stocks have lagged bigger stocks this year, so may also benefit from playing catchup.”
