Phillips: How to Recession-Proof Your Portfolio

If an investor believes we are entering a period of recession they should do four primary things:


1. Look at their asset allocation and determine where they have the greatest exposure to risk.

2. Challenge their time horizon for investing.

3. Determine how to rebalance the portfolio to reduce the risk identified.

4. Determine how much cash to raise as a hedge.

Reducing exposure to stocks is the obvious move we think of when we expect the economy to slow. But not all stocks are created equal.

The industries that are the most negatively impacted during a recession tend to be: real estate, luxury items, banking, industrial materials, commodities, and discretionary consumer goods.

On the other hand, the industries that tend to be the most defensive are: consumer staples, health care, utilities, and dividend paying stocks.

In addition, the size of a company generally impacts its price movement, as smaller companies tend to have more debt on their balance sheets and may not be as diversified in terms of income streams as their larger brethren. Accordingly, their stock prices tend to have larger negative reaction to a recessionary environment.

When adjusting a portfolio in response to recession concerns, investors should not forget to look over their bond exposure. Over the past few years, many investors have been seeking yield in a low-yield environment. They may have found it in the high-yield bond market.

If we are entering a recessionary period, high-yield bonds can have as large of a negative price reaction as stocks. These bonds have a higher yield for a reason. Financially, they are not as strong as those from companies with higher credit ratings and lower yields. An investor needs to be aware of the possibility of default risk as well.

When investing in stocks during recessionary periods, the relatively safest places to invest are in high quality companies with long histories. Their size and depth help them handle prolonged periods of weakness. In my opinion, companies that are either expanding into a known trend or that are paying consistent dividends are what investors should seek out.

For example:

Express Scripts. Express Scripts will benefit from the trend of the aging of the population and a strong generic drug launch cycle through 2015. The North American pharmaceutical market represents sales of about $300 billion per year.

Between now and 2015, $100 billion of this market goes off patent and to generic production. Express Scripts makes better margins on fulfilling generic prescriptions. ESRX recently received board approval to increase its buyback program to 65.1 million shares from 15 million. That would be over 10 percent of current outstanding shares.

Johnson & Johnson. J&J is the world’s largest health care company. It has consistently raised its dividend for the past 16 years and currently is trading around 13.5 times earnings and paying a dividend yield of 3.4 percent.

We think that J&J is likely to continue buying back stock in a major way as well. It repurchased $435 million in the March quarter. If the stock declines in value due to recession concerns, we believe management will take the opportunity to further reduce the shares outstanding.

Vodaphone. Vodaphone is broadly diversified by having operations in 26 countries as well as owning 45 percent of Verizon Wireless . The company currently pays a dividend of 5.4 percent and trades about 10 times earnings.

We believe Vodaphone should continue to generate excess cash for share buybacks and increases in dividends. Furthermore, we believe it will continue to perform decently, even in a recession, as consumers are consistently becoming more dependent on the conveniences and efficiencies provided by their cellular devices.

Bob Phillips will share more investing advice today on "Power Lunch," 1-2pm ET, as part of a special week-long series, "Hands-On Investing."


Phillips ESRX and VOD and both stocks are in his client portfolios. He does not currently own JNJ, nor is it currently in his client portfolios. _________________________

Bob Phillips is managing partner and co-founder of Spectrum Management Group in Indianapolis, Ind.