While the stock market has been relatively strong over the past few weeks, there are many signs that the economy isn’t very strong. Last quarter’s GDP figures showed that the economy is stagnant, and we also saw that retail sales have been relatively weak in the past couple of months.
With these points in mind, it makes sense to include a couple of defensive stocks in your portfolio. But what constitutes a “defensive” stock? While there is no single answer to this question, there are several characteristics that you want to have in stocks that you own during a recession. First and foremost, the company needs to be able to generate strong free cash-flow even if economic activity is slowing down. This would eliminate most industrial companies, as well as many consumer discretionary stocks because business investment will decline and so will consumer spending. Stocks that should be able to generate strong free cash-flow include utilities and consumer staple names. These companies sell products that people need to buy even if they have less money to spend.
Companies that collect regular payments in exchange for products that people need or products that cost very little are good places to look. For instance, people aren’t going to cancel their phone service in a recession unless things are really bad. But they might cancel a magazine subscription or HBO.
Given these points, I think investors should consider the following stocks for their portfolios. They won’t rocket higher in an up market, but they will pay dividends and retain their value in the event of a market correction or in a recession.