Investors are steeling themselves for a recession as central bankers and politicians struggle to get soaring inflation under control.
During troubled times, the conventional advice to investors is ‘don’t panic’ and look to the long term, but it is always worth reviewing your portfolio to ensure it is well positioned against the worst shocks.
Investment bank Peel Hunt specialises in analysing small and mid-cap firms, and it got its sector teams to identify the companies they consider best placed to thrive in a tougher environment.
They came up with more than 80 stocks, which are revealed below.
Are you ready? During troubled times, the conventional advice to investors is ‘don’t panic’ and look to the long term
‘If there is a recession in the UK, it is likely to be a very unusual one,’ says Peel Hunt’s head of research Charles Hall.
‘In a normal recession, businesses reduce employment levels to match lower demand and maintain margins, but the issue currently is more the struggle to fill vacancies. The focus on the cost of living should result in a prioritisation of consumer spend.’
Hall also notes that while inflation of around 10 per cent is likely to materially outpace earnings growth in the short term, this situation is likely to reverse next year as cost increases plateau.
We look at the likelihood of a recession and which business sectors are likely to weather one best below.
Meanwhile, though many investors like to hold individual stocks, putting money in investment funds and trusts can be safer and less hassle.
A professional manager does the work of choosing investments, diversifying them across regions, sectors and asset classes, and rebalancing whenever they think it’s necessary.
Therefore we asked investment expert Jason Hollands, managing director of Bestinvest, to round up a few funds and trusts that might be suitable in the current uncertain climate too.
What small and mid cap stocks might stand up to a recession?
Here are some highlights from Peel Hunt’s list and selected quotes from its accompanying report. Find a full rundown of its stock picks below.
We expect demand for sports fashion to be robust through a recession: certainly footwear has proved to be in the past, and we see no reason, given the demographic and its habits, why this should change.
JD Sports Fashion has a younger demographic, and we believe that will prove helpful.
We have always thought that the last three things to ‘go’ in a recession are the Sky Sports Subscription, the monthly new pair of trainers, and the dog.
Peel Hunt’s Charles Hall: ‘If there is a recession in the UK, it is likely to be a very unusual one’
Food and vets are the large majority of sales at Pets at Home, and we believe the P&L [profit and loss statement] has more stability than perhaps the market believes.
When times are tough and value is increasingly important to consumers, Dunelm takes share.
The Dunelm customer base is a broad church, appealing to a wide spectrum of age and income groups.
Dunelm’s offer now covers more options across a wider range of categories, all with a very clear focus on value – whether a highly competitive opening price point to compete with the discounters and supermarkets, or a high-thread-count Egyptian cotton sheet that provides great value against the department stores.
Our view is that a consumer recession in the UK should not be a major concern for the sector. The UK-listed industrials space is made up of global supply chain companies with much of their exposure outside Great Britain.
That said, a recession usually has a negative impact on sentiment, and within the sector we would expect investors to aim for stocks that are perceived as safe havens.
There are a handful of stocks whose models have proved resilient over a long period of time and which we would expect to outperform in that scenario.
Spirax-Sarco’s steam specialties business covers defensive end markets (e.g food and beverages) as well as industrial ones, and the offer typically saves customers money by helping them use steam more efficiently
Halma and Diploma both have extremely impressive long-term growth track records, built on a combination of organic growth and M&A [mergers and acquisitions].
We believe AG Barr’s core earnings should prove very resilient, and it is underweight in food service. Irn Bru (47 per cent of sales) is considered a staple in Scotland. It is a fridge item and the first on many consumers’ shopping list.
Like AG Barr, Britvic has a strong portfolio of brand leaders, and in the last major UK recession its core revenue grew 4.8 per cent while the UK soft drinks market fell 0.8 per cent.
The eyewear industry is resilient in a recession, given that the majority of frames are for eye correction.
Inspecs’ business is focused on the value and mid-price ranges, which should gain share in a tougher consumer environment.
In normal downturns we would be concerned about sunglasses sales as consumers cut back on holidays. However, sales of sunglasses have been curtailed by Covid and so volumes should recover as travel resumes. Sunglasses were 20-25 per cent of Inspecs’ sales pre-Covid.
While a global recession – should one materialise – would reduce demand versus present expectations, lowering commodity prices, the mining industry is not currently facing a wave of new capacity at the same time.
This means that we would expect prices to rebound quickly as economies start to recover.
At present we believe that copper, mineral sands and diamonds all look supply constrained and have limited to no supply growth under development.
This suggests that as demand accelerates these commodities could lead the recovery, driving sector-relative outperformance from those share prices.
Our top picks amongst those commodities are Atalaya Mining, Central Asia Metals, Kenmare Resources, Petra Diamonds and Antofagasta.
In the recession scenario outlined in this report, the gold names may prove a relative safe haven. We believe the gold stocks will outperform the market during the pullback phase (much like in late first quarter 2020) and in the initial stages of a rebound (similar to second quarter 2020).
Our top picks in the gold sector are currently Pan African Resources, Pure Gold Mining (post its present [fund] raise), Wheaton Precious Metals and Yamana Gold.
Leisure travel and hotels
TUI, Carnival, On the Beach and Hostelworld all look set for excellent summer 2022 trading, as consumers catch up on overseas travel after the disruption caused by the pandemic.
Historically, consumers have proven reluctant to sacrifice holidays entirely, and have been more likely to flex the amount they spend.
Holiday expenditure can be reduced by trading down in terms of duration or daily price-point, and such trading down is not necessarily negative for contribution to operator profits.
InterContinental Hotels Group and Whitbread have both reported a strong rebound in demand in their core businesses.
Both companies are market leaders and likely to benefit from financially weaker competitors, particularly those without relevant brands, exiting the market
In the specialist lending sector, we continue to believe that the current valuations of OneSavings Bank and Paragon Banking Group are overly pessimistic with regards to the macro risks facing these businesses.
If, as seems likely, markets remain volatile given macro uncertainties, it is difficult to see many asset managers’ share prices outperforming in the shortterm. Where we do see an opportunity is in the investment platforms. In particular, we see IntegraFin as being a compelling opportunity, even in a recession.
Healthcare has historically been relatively resistant to recessionary impacts, because spending tends not to be deferred, due to the steady and growing need from our populations
In our view the [Abcam] brand continues to get stronger and is breaking more and more ground with pharma/biotech, giving it yet more pricing power
After a transformative year, when Oxford BioMedica’s capabilities were really put in the international shop window (100 million doses of the Oxford/AstraZeneca Covid-19 vaccine manufactured), the FY21A financials and operational progress look impressive.
We see this as a real opportunity to buy in to an exciting growth story (we believe the next four years have the potential to be as transformative as the last four).
UK biotech is not in favour at the moment, and cell and gene therapy (C>) has been particularly punished. With much of Syncona’s portfolio made up of C>, it has also been aggressively sold off (-20 per cent year to date). We believe investors with a long-term viewpoint should look very hard at Syncona.
Should investors steel themselves for a recession?
The UK is facing tough time whether or not it enters a technical recession – meaning two quarters of negative growth in a row – say investing experts.
‘It seems that inflation has not yet peaked and economic growth is sluggish, much as elsewhere globally,’ says Richard Hunter, head of markets at Interactive Investor.
‘However, recession is never guaranteed and there are some pockets of optimism for investors to consider.
‘The pandemic changed the mindset of some workers and Brexit led to an exodus of freely available overseas staff.
Richard Hunter: ‘Recession is never guaranteed and there are some pockets of optimism for investors to consider’
‘As such, there is something of a labour shortage, particularly in areas such as hospitality and leisure.’
Hunter says this could put upward pressure on wage growth, which could be positive for consumers though it would not help to curb inflation.
He also points out that many people built a cushion of savings and paid down some of their debt during the Covid restrictions, so could have more disposable income than expected.
‘Some of the recent numbers from the airlines and holiday companies imply that demand is strong ahead of the imminent holiday season, due to the release of pent-up demand.
‘At the same time, the demand/supply imbalance in the housing market is resulting in higher house prices, which should of course benefit the housebuilding sector.’
But Hunter says that regardless of any resilience which the UK might display, there is an air of caution in global markets as central banks try to tackle inflation without killing growth and tipping economies into recession.
‘Investors should still take a longer term view of market prospects, especially given that the nearer term is likely to be accompanied by the volatility which has been evident so far this year,’ he says.
‘Certain defensive stocks have held up reasonably well and are still displaying promise. In particular, companies with pricing power – the ability to pass on most of the price rises to consumers without affecting demand – are attracting attention.
‘These may range from the likes of drinks company Diageo to household product providers such as Unilever and Reckitt.’
Which sectors are most resilient to recession?
‘The economy is clearly facing a tough period ahead as rampant inflation coupled with higher tax hits consumption, the biggest component of UK GDP,’ says Jason Hollands, managing director of Bestinvest.
‘At a time of slowing growth, high inflation and rising borrowing costs, investors should generally avoid heavy exposure to UK domestically focused cyclical stocks.’
These are those sensitive to the state of the economy, which are typically more prevalent in the mid cap and smaller companies space, he explains.
Jason Hollands: ‘The economy is clearly facing a tough period ahead as rampant inflation coupled with higher tax hits consumption’
Meanwhile, defensive sectors that should prove more resilient include consumer staples, the types of businesses that make every day stuff people will keep on buying whatever the state of the economy, he goes on.
Hollands also identifies healthcare stocks, businesses with high recurring income models on long term contracts, and companies that benefit from structural themes or government incentives and spending such as renewable energy infrastructure.
He notes that Peel Hunt’s full list of recession resilient stocks (see below) includes pubs companies, healthcare firms and a renewables infrastructure investment trust.
‘Alongside these, I would flag sectors like defence stocks and tobacco as recession resilient – though some investors will want to avoid these for ESG [environment, social and governance] reasons,’ says Hollands.
‘In the case of defence stocks, Government order books are multi-year in nature and defence spending is going to rise significantly in Europe as a result of the war in Ukraine.
‘Tobacco, which is undoubtedly a controversial product, is also highly cash generative and smokers do not give up just because the economy is experiencing a weak spot.’
What about funds and trusts?
Jason Hollands of Bestinvest says his firm’s best funds list includes a couple of investment trusts with capital preservation mandates which are also flagged by Peel Hunt.
Personal Assets Trust and the Ruffer Investment Company both take a multi-asset approach that blends exposure to blue chip equities with inflation-linked bonds, physical gold and short-dated bonds, says Hollands.
‘Such strategies typically prove defensive during periods of market turbulence.’
He says people who prefer investing in funds rather than individual stocks and shares might also consider TB Evenlode Income and Liontrust UK Growth.
‘The companies in the TB Evenlode Income funds are estimated to generate more than 80 per cent of their revenues outside of the UK, so it is has relatively low exposure to the domestic economy compared to most UK equity funds.
‘It targets companies with strong free cashflow and it has high weightings to staples like food, beverages and other staples, examples being Diageo and Unilever.
‘The Liontrust UK Growth fund generally avoids highly cyclical sectors and instead focuses on companies with qualities that provide a strong barrier to competition and high recurring earnings, that enables them to maintain profitability throughout the economic cycle.
‘Top holdings include healthcare firms AstraZeneca and GlaxoSmithKline, consumer staples giant Unilever and drinks group Diageo, as well as defence groups Ultra Electronics and BAE Systems.’
Small and mid-cap companies to rely on in a recession?
Peel Hunt analysts compiled the following stocks list, across a wide range of sectors
• 888 Holdings
• accesso Technology
• AG Barr
• Atalaya Mining
• Auction Technology Group
• Auto Trader
• Avon Protection
• Babcock International
• Balfour Beatty
• Blancco Technology
• Capricorn Energy
• Central Asia Metals
• City Pub Group
• CMC Markets
• CVS Group
• Diversified Energy Company
• Domino’s Pizza
• Flutter Entertainment
• Fuller Smith & Turner
• Galliford Try
• Gamma Communications
• Harbour Energy
• Hikma Pharmaceuticals
• Hilton Food
• Hollywood Bowl
• InterContinental Hotels Group
• J D Wetherspoon
• JD Sports Fashion
• Kenmare Resources
• LondonMetric Property
• Mitchells & Butlers
• Spire Healthcare
• Supermarket Income REIT
• Telecom Plus
• Ten Entertainment
• TP ICAP
• Wheaton Precious Metals
• Yamana Gold
• Personal Assets Trust
• Ruffer Investment Company
• BB Biotech
• Octopus Renewables Infrastructure
• Gresham House Energy Storage