Does a Bad Economy Equal a Bad Stock Market?

Includes: XLP, XLU, XLV
by: Michael Panzner

Even if you don't buy my argument that the far-reaching liquidation pressures associated with the bursting of the biggest credit-bubble in history will ultimately hammer equities along with almost every other asset class, history suggests that a recession -- which is growing ever more likely by the day -- is bad news for share prices. In "Preparing Stock Players for a Recession," the New York Sun's Dan Dorfman reports on what happened during past U.S. downturns.

Okay, let's say the economic bears are right, the economy goes into a deeper than expected slide, and we get slammed with a nasty recession. What then for the country's roughly 80 million stock players? What kind of market losses might they expect, and what would be the smartest portfolio strategy to pursue?

In an intriguing research exercise, the chief investment strategist of Standard & Poor's, Sam Stovall, has taken a probing look at what happened to the stock market during the last 11 recessions, dating back to 1945, and offers up some telling disclosures. For starters, recessions, as you might expect, can be devastating to the stock market, with the S&P 500 in one instance — between March and November 2001 — falling more than 49%.

With recession forecasts continuing to swell, such an exercise is especially topical at this juncture. For example, a former Federal Reserve chief, Alan Greenspan, recently added his two cents to the debate, asserting, "the probabilities of a recession have moved up to 50%." An economist at Morgan Stanley, Richard Berner, has also served up bum tidings, warning, "A mild recession is now likely, with no growth for the year ahead."

Recessions, defined by two consecutive quarterly declines in the gross national product, have occurred, on average, about every 5 1/2 years in the post-World War II period. Overall, they run from six to 16 months, with the average lasting 10 months. With the current economic expansion about six years old, the unmistakable recession message may be overdue. The average loss to equity prices during recessions, as measured by the S&P 500, was 26%, according to Mr. Stovall, with the declines ranging from as little as 7% to a high of 49.1%.

If you think you can escape a recession by investing in those hot overseas markets, forget it. Because of America's influence on the global markets, recession periods have also led to an average 23% decline internationally, as reflected in the MSCI-EAFE index, a benchmark of large multinational companies in developed nations.

In America, there are few places to hide during recessions, Mr. Stovall says, what with all 10 sectors of the S&P 500 posting declines during these periods. The smallest drops were recorded by traditionally defensive sectors: consumer staples, health care, and utilities. The worst performers were industrials, materials, consumer discretionary, and energy. Only three groups turned in positive returns during recession periods: tobacco, household products, and alcoholic beverages.

Which stocks represent the best recession fighters? Among S&P's top defensive picks are eight companies with five-star S&P ratings that are pegged as potential 20% to 35% gainers over the next 12 months. The companies, with health care in the forefront and their projected percentage gains in parentheses, are Mindray Medical International (NYSE:MR) (35%), Thermo Fisher Scientific (NYSE:TMO) (34%), Bristol-Myers Squibb (NYSE:BMY) (31%), Psychiatric Solutions (OTCPK:PSYS) (30%), Laboratory Corp. of America (NYSE:LH) (23%), Schering-Plough (SGP) (23%), Aetna (NYSE:AET) (21%), CVS Caremark (NYSE:CVS) (20%), and Icon (NASDAQ:ICLR)(20%). For investors fearful of a recession, S&P thinks they could increase their portfolio exposure to exchange-traded funds that emulate the performance of traditionally defensive sectors. These ETFs are Select Sector SPDR-Consumer Staples, which trades under the symbol XLP, Select Sector SPDRHealth Care (NYSEARCA:XLV), and Select Sector SPDR-Utilities (NYSEARCA:XLU).