Following the COVID-19 market crash, stocks quickly raced back to all-time-highs in a dramatic and unexpected rally. Supported by major central bank intervention and aggressive fiscal policy, the markets recovered with impressive speed. It was a welcome development–especially for those who bought the dip.
Now, however, stocks are starting to seem overpriced. Prices are back to where they were before COVID-19, despite most companies’ earnings having fallen since the pandemic began. According to the Wall Street Journal, the S&P 500 Composite Index has a 32 P/E ratio. That’s historically high: It was at 23 just a year ago.
In this environment, it would be naive not to at least consider the possibility of another market crash. Stocks seem to be pricing in a rapid recovery from COVID-19, but it’s not clear that that will happen. A second wave of COVID-19 would threaten the vast majority of industries; some, like airlines, are already forecasting long-term damage.
Nevertheless, you can still invest successfully in this environment. As you’re about to see, there’s an entire category of assets that can perform well even in economies like the current one. Better still, many of them have upside in good economies, too.
Non-cyclical defensive stocks are equities whose earnings don’t vary much with the broader economy. Examples include grocery stores, utilities and toilet paper. These items are basic necessities of life that you have to buy even when the economy is poor.
If you were laid off and forced to live on EI, you might delay a car purchase, but you’d keep buying groceries. Companies that sell staple products/services therefore tend to fare well in recessions.
Of course, stocks can crash for reasons other than recessions. If the market decides that stocks are just too expensive, then non-cyclicals should fall right along with cyclicals. However, non-cyclical stocks tend to fare better in market downturns brought on by weak economic fundamentals.
One example of a non-cyclical stock is Fortis Inc (TSX:FTS)(NYSE:FTS). It’s a Canadian utility that provides gas and electricity in Canada, the U.S. and Latin America. The company’s core service–heat and light–is a classic non-cyclical staple. Consumers still need to heat their homes even when times are hard.
They would sooner sell their cars than shut off their power. Additionally, utilities tend to be provided on long-term contracts that aren’t easy to just cancel. Companies like Fortis therefore have two major factors that contribute to unusual revenue stability.
The proof is in the pudding: In 2008 and 2009–the years of the global recession–Fortis grew its earnings for two years in a row. In the first quarter of this year, it also grew its earnings by a tiny percentage. Over the past 46 years–a period that has included several recessions–Fortis has increased its dividend every single year.
Clearly, this is a non-cyclical stock with a proven track record of weathering economic storms. It would make a valuable addition to a well-diversified portfolio of Canadian stocks.
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Fool contributor Andrew Button has no position in any of the stocks mentioned. The Motley Fool recommends FORTIS INC.