Investing in small caps during recessions has generated superior investment returns, according to our back-testing of the data to the late 1980s (see Table 1, below).
Stocks like discount retailers (Ross, TJX, dollar general, etc), alcohol stocks, and DIY auto repair stocks, tend to perform well in a recession when people lose their jobs.
Seek Out Core Sector Stocks
If you want to insulate yourself during a recession partly with stocks, consider investing in the healthcare, utilities and consumer goods sectors. People are still going to spend money on medical care, household items, electricity and food, regardless of the state of the economy.
It's typically a great time to invest in small-cap stocks when the economy is rebounding, unemployment rates are decreasing quickly, and businesses are seeing strong earnings growth. Of course, small-cap stocks don't always outperform.
The overall quality of publicly traded small caps has deteriorated, as private sponsors help top performers stay private for longer. Instead of small caps, investors should consider actively adding exposure to U.S. large-cap value and mid-cap growth stocks.
While small caps have historically outperformed their large-cap brethren in periods when annual inflation has exceeded 1%, the higher interest rates that come when central banks try to reduce high inflation can be challenging for small companies.
Avoiding highly indebted companies, high-yield bonds and speculative investments will be important during a recession to ensure your portfolio is not exposed to unnecessary risk. Instead, it's better to focus on high-quality government securities, investment-grade bonds and companies with sound balance sheets.
"Gold is often considered a safe-haven asset in times of economic uncertainty due to its perceived store of value," Collins says. "During recessions, gold prices may rise as investors look for ways to protect their wealth from market volatility."
For nonretirees, that means setting aside three to six months' worth of living expenses in a relatively safe, liquid account—such as an interest-bearing checking account, money market savings account, money market fund, or short-term CD—plus enough cash to cover any upcoming sizable expenses, such as tuition payments.
“The demand for travel and hospitality services typically declines as consumers cut back on discretionary spending,” Sarib Rehman, CEO of Flipcost, said. “To attract customers, airlines, hotels and travel agencies often lower their prices and offer more promotions.”
Apple. Apple (NASDAQ: AAPL) has ranked as the largest holding in Buffett's Berkshire Hathaway portfolio for several years. The iPhone maker is still at the top early in the new year. Berkshire owns 300 million shares of Apple worth around $73.2 billion, representing 24.8% of its total holdings.
Stocks and bonds have relatively low transaction costs, allow you to diversify more easily and leave your cash more liquid than real estate (although the stock market is typically more volatile than the housing market). Meanwhile, real estate is a hedge against inflation and has tax advantages.
Given the changing macroeconomic backdrop, we outline why we see potential value for investors in small caps in 2024. The consensus is that interest rates look to have peaked, with markets now pricing in cuts across many major economies in 2024, something which could prove beneficial to small caps.
The industries known to fare better during recessions are generally those that supply the population with essentials we can't live without. They include utilities, healthcare, consumer staples, and, in some pundits' opinions, maybe even technology.
Small-cap funds are riskier than large-cap funds and may not be suitable for everyone. Small-cap companies are more sensitive to market changes and can experience sudden and wide price fluctuations. Small-cap companies are less popular and smaller in size, making their stock less liquid.
In a recession, it's smart to preserve your capital by investing in safer assets, such as bonds, particularly government bonds, which can perform well during economic downturns.
When things are looking bleak, consider holding on to your investments. Selling during market lows can be one of the worst things you can do for your portfolio — it locks in losses. When the market evens out down the road, rebalancing may be in order.
When purchasing a home, you have the choice of an adjustable-rate mortgage (ARM) or a fixed-rate mortgage. Interest rates usually fall early in a recession and then rise later as the economy recovers. This means that the adjustable rate for a loan taken out during a recession is likely to rise once the downturn ends.
Cash delivers safety in troubled times. Experts recommend keeping three to six months' worth of cash to cover living expenses when people lose their jobs. For businesses, maintaining liquidity through a recession can making the difference between shutting the doors or surviving the downturn.
Typically, in recessions, the demand for houses declines and as a result house prices will fall. This was the case in the last recession back in 2008 when the housing bubble burst and the recession began.
In a nutshell, a recession can be a great time to buy the stocks of top-notch businesses at favorable prices, but there's no need to put all of your money to work at the same time, regardless of how cheap stocks look.
The Federal Reserve's interest rate cuts are another reason why small-cap stocks are well-positioned for growth in 2025. Small-cap companies tend to be more reliant on borrowed money, and falling interest rates make it cheaper for these companies to take on debt.
We expect earnings to drive the next leg higher for small-cap share prices. Analysts are looking for robust earnings growth: 15% this year, and by over 30% in 2025 and 2026. That is ahead of the long run rate of 13% growth (see Exhibit 3).
Historically, small cap stocks have generated higher returns than their larger peers over extended periods. That's because smaller businesses are earlier in their maturation and have more room to grow than larger companies.