Recession playbook: Here are some of Wall street's top stock picks for a downturn

Published Sun, Jul 3 20229:45 PM EDT

A growing number on Wall Street are talking up the risk of a recession, with Goldman Sachs , Deutsche Bank and more all pointing to a higher probability of a downturn. "Economic data points indicate a higher probability of recession," Morgan Stanley analysts said in a June 29 note. "Since the beginning of the year, we have seen record level inflation ... a 170 bps [basis points] increase in the 10-yr Treasury yield , a historic 75 bp rate hike by the Fed to combat rising inflation, and consumer and business sentiment turn meaningfully more negative." The S & P 500 , meanwhile, has just had its worst first-half of the year since 1970 , plunging nearly 20%. And Goldman says to expect more instability ahead. "Until the growth/inflation mix improves markets are likely to remain volatile as investors shift between inflation frustration and recession obsession," the bank wrote on June 29. "We look for opportunities to add risk for 12m; while the likelihood of a recession has increased, we wouldn't expect it to be deep or prolonged." Here are some of Wall Street's favorite stocks if a recession becomes a reality. Buy low risk, discounted names in utilities The utilities sector has already beaten the S & P 500 by around 15% year to date, and could continue to outperform "modestly" in the event of a weakening economy or full recession, according to Morgan Stanley. The investment bank says that if a recession occurs, it expects low risk names to outperform the market. It picked American Electric Power , Exelon and Atmos Energy as value names with good upside potential, "low risk characteristics," and trading at discounts. Read more Is the bear market coming to an end? Here’s one indicator pros say to watch closely Morgan Stanley loves these 9 global stocks trading at ‘significant’ lows This fund manager is beating the market — and he has 4 tips for investors "We think utilities with low risk around regulatory, climate, economic, and earnings issues will be best positioned to outperform in the event of a recession," Morgan Stanley analysts wrote in "utility and clean tech recession playbook." Demand for clean energy could be robust The bank also believes that within the clean tech sector, a select group of stocks with earnings tailwinds could beat their peers in the near term. It says the highest quality names, such as Sunrun , Plug Power , AES and Solaredge Technologies , could continue to see strong fundamental business performance through a recession. "We believe that the demand for clean energy technologies will remain strong, even if we head into a recession, given the deflationary cost characteristics (i.e. saving customers money when wallets are tightening) and superior reliability provided by these technologies," the analysts wrote. But Morgan Stanley warned that the broader clean tech sector may not beat the overall market during a downturn, if history is any guide. At present, clean tech has outperformed the S & P 500 by 12% year-to-date. Look to small- and mid-caps Bank of America says that despite volatility in the markets, the "route to alpha" within small-cap firms has remained consistent. Alpha is the measure of an investment's performance compared to a benchmark. In a note on June 30, the bank named a number of small- and mid-cap stocks on the Russell 2000 and Russell Midcap indexes which it said have historically fared best during times of recession. It considered high quality stocks — those that have higher profitability with a record of stable business performance over time — and risk factors, as well as companies' ability to return dividends to shareholders. The buy-rated stocks that turned up on Bank of America's screen included auto parts retailer O'Reilly Automotive , food company Hershey , healthcare firm Chemed Corporation , and electronics and fiber optic connector maker Amphenol . Industrial tech firm Vontier , analytics firm EXL Service , and packaging company Avery Dennison also made the list. Meaningful downside risk Evercore ISI said increasing concerns of a downturn had led it to assess which of the tech and IT stocks it covers might be best placed in a downturn. In a note on June 27, the advisory firm said it thinks there remains a "meaningful downside risk (median ~30-40% vs. current levels) assuming a recession scenario." However it said stocks including Check Point Software Technologies , Dell , IBM and Palo Alto Networks have lower downside risk potential (less than 20% downside). "We think a high degree of revenue visibility, customer/end market diversity, strong balance sheet, less cyclical risk and/or secular growth drivers should help insulate these companies from macro headwinds," the analysts wrote. They also noted that, when looking at past performance during recessions, Dell and IBM in particular, had successfully managed to protect their margins.

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