This column was originally published on RealMoney on Sept. 10, 2007 at 11:46 a.m. EDT. It's being republished as a bonus for TheStreet.com readers. For more information about subscribing to RealMoney, please click here.
The release of the seemingly rotten employment numbers
last Friday has opened many more people up to
the possibility of a recession. This article will not focus on whether there will be a
recession. I do, however, suggest what to do with sector weightings within your
portfolio to try to ride out a downturn until the next cycle begins.
Financial sector -- 19.81% of the S&P 500
: A precursor to a recession is often an inverted
yield curve. Curve inversion impedes success within the financials, and the best thing to do when the curve inverts is to simply
sector. I first started expressing concern about the slope of the curve
My preference for the time being is to remain underweight, favor high-
yielding foreign banks and wait for the yield curve to normalize before adding
volatility back in with the brokerages or exchange stocks. I would not want to own small or volatile or narrowly based companies (like mortgage only) until the yield curve normalizes.
Tech -- 16.35%
: Tech is an area where you can get very divergent opinions, but I remain underweight the sector. The bull case now is compelling because tech has struggled for so long,
growth has lagged value for ages and all the cash that companies have on their
balance sheets should lead to increased spending on capital expenditures, which, if it happens, would benefit tech.
For now, I think the bull case relies on too many "shoulds," but if we are in for a slowdown/recession, I would expect semiconductors to lead off the bottom, as they usually do. Semis are an early-cycle play because they are an elemental component in almost everything we buy.
Health care -- 11.73%
: Health care stocks usually do well during recessions because the demand for their products is inelastic. No matter what is going on in the economy or the world, people will still take their heart pills or blood pressure medication. The aspect of safety (and in some cases, the yield available) draws investment demand. This bodes well for stocks like
Johnson & Johnson
This is a sector that I would want to be
overweight during a recession, and additionally, the graying of the boomer generation offers a fundamental demographic play.
Energy -- 11.41%
: Energy is a group that you might expect to do poorly because an economic slowdown implies less demand for oil. I believe that even bigger than a slowdown in the U.S., and wherever else in the world that might domino to, is the ascendancy of the middle class in
emerging markets and their increased demand for energy.
If that stands up, I would want to be equalweight energy but favor foreign companies over domestic and blend together some yield, from large integrated oils, and the more niche oil sands theme.
Industrials -- 11.37%
: If you own several industrial stocks, it is a good bet that a couple of them will take 30%-40% hits in a recession. This doesn't make them bad companies -- it's just what happens. Big, heavy, metal things are expensive, and demand for them goes down when the economy slows.
This is a group to underweight, but I would not suggest zero weight, because I believe going zero anything is a very big bet. Defense stocks have a chance to hold up better than stocks like
have in past market downturns. I also think that stocks that play into the industrial part of the global water theme have a chance to do a little better than down 40%.
Consumer discretionary -- 9.51%
: This is another sector to underweight. The news on Friday from
is the perfect example of why this is. People are simply less likely to upgrade their TV during a recession.
This is already starting to be a factor as the discretionary sector -- as measured by the
Discretionary Sector SPDR
ETF -- has badly lagged the
for the last couple of months.
Consumer staples -- 9.47%
: This is a group to overweight in a recession. Regardless of what it says about society, people still want their cigarettes and booze. They also need razors, ketchup, Nilla Wafers and toothpaste, so companies like
will continue to thrive.
Additionally, this sector is a great place to add yield, especially in the tobacco and food stocks.
Telecom -- 3.67%
: Telecom breaks into two bigger subsectors -- equipment makers and the Ma Bell type of companies. I would want to be overweight the Ma Bells for their yield and would want foreign exposure. A lot of big foreign phone companies have their business at home, plus they have meaningful footprints in emerging markets. This provides a little growth, and most of them offer a lot of yield.
Utilities -- 3.47%
: If interest rates come down, that should help utilities. If the economy slows down, that implies less demand for electricity, which hurts utilities. In weighing the two, I am inclined to want to be overweight for the yield and the low volatility; I believe stocks like
are a good way to get exposure.
Materials -- 3.08%
: History says to underweight this group, and I'll agree on the chemical stocks, but the emerging market ascendancy theme embedded into the natural-resources stocks leaves me choosing to overweight that part of the materials sector.
A few of the names here have some good yield and a lot of the names are foreign. A foreign miner selling some sort of ore to China probably doesn't have much of a fundamental link to a U.S. slowdown.
Consistent with a slowdown is lower rates, which usually weaken the dollar. Some exposure to foreign currencies and bonds also makes sense. Some commodity exposure could also help offset a decline in equities that should be expected in a recession.
From 30,000 feet, the idea is to reduce volatility, increase yield and reduce net long exposure a little. Be careful with that last one, though. Markets tend to go up very quickly off the bottom. Too little exposure when the market turns will lead to a bad result.
Instead of selling a lot of stock, my preference is to add leveraged inverse
index funds to neutralize some of the
long exposure, which you can read more about
This column was originally published on RealMoney. For more information about subscribing to RealMoney, please click here.
At the time of publication, Nusbaum was long JNJ, MO and ED for clients, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
to send him an email.