Op-ed: Here’s a midyear stock-picking guide for both bears and bulls amid recession debate

At the midpoint of 2023, some investors see a recession storm on the horizon while others see clear skies ahead.

The recession crowd is worried about negative consumer sentiment, while the no-recession camp is heartened by more-positive-than-expected data from the University of Michigan Consumer Sentiment Survey, released in June.

Economic pessimists fret over corporate earnings, but optimists point out that an anticipated earnings apocalypse failed to arrive in the first quarter, when earnings beat expectations. The former worry about more Fed interest rate increases, while the latter point to declining inflation.

Recessions haven’t always resulted in declining stock markets, and good opportunities can be found amid them. Nevertheless, recessionary business environments generally aren’t good for corporate earnings, and investors’ perceptions are, of course, highly impactful.

Investors convinced that a recession impacting the market is imminent continue to sit on cash. But some of them might be inclined to invest for the long term in sectors unlikely to suffer heavy damage from a receding economy.

Here’s a midyear sector guide for both economic optimists and pessimists.

The best sectors for recession disbelievers are the most economically sensitive ones: industrials, materials and financials.

Industrials, which manufacture finished products for commercial and consumer use, recently have been picking up steam; SPDR Industrial Select Sector ETF XLI was up 8% over the three months that ended in mid-June.

Industrial names with currently low downside risk and good growth potential include: Cintas, Fastenal, Westinghouse Air Brake Co., Cummins Inc., CSX, Emerson Electric, Otis Worldwide, Carrier, Caterpillar, Honeywell, Illinois Tool Works and Lockheed Martin Corp.

Materials companies, an opaque sector to most individual investors, comprise five industry groups: metals and mining, chemicals, containers and packaging, construction materials, and paper/forest products. Materials are what industrial companies use to make products so, without them, nothing gets built. This is a small sector, but its output directly affects all the others.

After a rough 2023 thus far, materials stock prices are rock-bottom low, having lagged over the last 12 months (-9% versus +4% for the S&P 500 Index). Well-positioned companies with good growth prospects currently include: Corteva, Dow Chemical, Ecolab, Linde plc, Martin Marietta Materials, Nucor Corp., PPG Industries and Sherwin-Williams.

Both industrials and materials will likely get a boost over the next couple of years from the nascent trend of reshoring or onshoring. Those terms refer to American manufacturers seeking to relocate their plants in other countries to American soil to avoid supply-chain disruptions from shutdowns and shipping bottlenecks like those of the pandemic.

Another tailwind for these two sectors, especially materials, is the trillions of dollars in incentives available from recently passed congressional legislation to spur capital investment in domestic infrastructure, clean energy and technology. These initiatives will spur industrial growth and increase the use of materials for construction and green manufacturing.

The most economically sensitive sector may be financials. As of mid-June, SPDR Financial Select Sector ETF XLF was down about 2.16% year to date but up 7.73% for the preceding three months.

This growth has come as regional-bank fears have abated and investor confidence in banks has increased. This confidence reflects industry strength related to higher capital reserves, required since the financial crisis of 2008.

Net operating income is at an all-time high, and the sector is trading at an average price-earnings ratio of about 8.5 — well below its three-year average of 12.1. And insurance companies, which have much of their treasure in bonds, are benefiting substantially from highly elevated bond yields.

Names positioned for likely growth over the next year or two include: Aflac, JPMorgan Chase, T. Rowe Price Group Inc., Willis Towers Watson, American International Group, Allstate, The Hartford, and Marsh & McLennan.

For those convinced recession is imminent, there aren’t as many choices. Yet there are two clear equity refuges for weathering a recessionary storm: consumer staples and health care.

Consumer staples companies produce retail goods that people buy regardless of what the economy is doing — food, personal care items and household products. During recessions, people still eat, bathe, clean their homes and do laundry.

Still suppressed from the bear market, most consumer staples ETFs have had low single-digit returns this year. Currently buyable names include: Campbell Soup Co., General Mills, The Hershey Co., Kellogg’s, Kimberly-Clark Corp., Kroger, Procter & Gamble and Walmart.

Health care is also still beaten up from the bear market, with many sector ETFs posting low single-digit or flat returns this year. But long-term demand for medical services, supplies and devices is certain in a nation where more than 10,000 Americans turn 65 each day. These demographics make health care both a defensive sector and a perennial offensive play.

Pent-up demand from patients who had put off elective surgeries, such as hip and knee replacements, until after the pandemic remains quite strong as patients wait to get into operating rooms. This has dinged some health insurers but has helped health-care companies, including those held by iShares U.S. Medical Devices ETF (IHI), which is up 7.3% for the three-month period ended in mid-June.

Sector names with reasonable risk levels and good growth prospects include: Vertex Pharmaceuticals, IDEXX Laboratories, DaVita Inc., Veeva Systems Inc., IQVIA Holdings Inc., Cigna Group and Zoetis Inc.

Recession or no, there’s one sector that should work for both camps: technology. In May, the Nasdaq entered bull territory, and projections suggest this bovine will run well into next year, at least. Twelve-month forward earnings forecasts for the sector have been revised upward 20% since November, compared to only 3% for the S&P 500.

As tech earnings gain momentum, high-priced megacap tech behemoths dominate growth funds. Meanwhile, smaller, lower-valuation companies with good growth prospects are being overlooked. Relatively low-risk stocks with good potential in a category I call TARP — tech at a reasonable price — currently include: Cognizant Technology, Cisco, FLEETCOR Technologies, CDW, Amphenol, Keysight Technologies Inc., ADP and Motorola Solutions Inc.

As the market always looks forward and equity growth seems to be broadening, the investing priorities of no-recession bulls and recession bears focused on the long term may be starting to overlap.  

— By Dave Sheaff Gilreath, certified financial planner and partner and chief investment officer of Sheaff Brock Investment Advisors, LLC, and Innovative Portfolios