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UBS: These 10 stocks will help you protect your portfolio from recession risk while preparing for future recovery

Jamie Cameron
12. 10. 2022
6 min read

Markets around the world are giving warning signs that the global economy is teetering on the edge of a cliff. The question of recession is no longer if, but when. Investors should therefore bet on defensive stocks, according to USB, but they should also monitor cyclical ones in case of an early recovery. Here are 10 stocks the bank recommends buying.

USB is Switzerland's largest bank and one of the world's largest

A trio of UBS $UBS+2.3% retail analysts - Michael Lasser, Atul Maheswari and Mark Carden - wrote in a Sept. 29 note that the current economic uncertainty is likely to keep stocks "range-bound at least in the near term." But because it is nearly impossible to time the market, the analysts say it is prudent to prepare for any outcome by building a balanced portfolio composed of both defensive and economically sensitive stocks.

"It is best to take a defensive stance for the next few months but maintain some offensive positioning for the longer term," the analysts wrote in a note. "Once the market sees a peak in rate hikes, this will likely signal a move to a more cyclical exposure within the group."

Focus on defensive stocks in a recession

In times when stock prices fluctuate sharply and equity indices tend to fall, investors should focus on defensive (anti-cyclical) stocks of stable companies. These stocks seemingly go against the natural cycle of the market, meaning that they are stocks of companies that perform relatively steadily regardless of the overall state of the economy. Defensive stocks provide goods or services for which there is stable demand at different stages of the business cycle. The most common example is consumer staples, basic necessities that consumers are unlikely to eliminate from their budgets in the event of an economic downturn. Moreover, dividend returns on defensive stocks are often solid.

Analysts have shared 5 defensive stocks that should fare significantly better than the rest of the market in the event of a recession. All five names have a buy rating from UBS except one, which has a neutral rating. These are discount retailer Dollar General $DGand+4.4% Dollar Tree $DLTR+0.7%. A discount retailer is a variant of a retailer trying to compete with traditional convenience stores and supermarkets primarily on the lowest possible price. Analysts also cite shares of auto parts retailers O'Reilly Automotive $ORLY+1.1%, Advance Auto Parts $AAP+0.2% and AutoZone $AZO+0.6%, which will continue to outperform in the near term.

Now let's take a closer look at the latter stock. While the stock market has come under pressure this year but auto parts retailers like AutoZone have performed better. Investors view AutoZone as a defensive company that can thrive in any economic environment. People need their cars to get to work, school or groceries, regardless of the state of the economy. When your car breaks down, your life stops and you need it fixed as quickly as possible.

AZO stock has added nearly 10% this year compared to the S&P 500 index, which has lost more than 21% as of Oct. 6

Obviously, some car owners will take their car to a repair shop that AutoZone supplies, but the company mostly caters to DIYers. To attract those customers, AutoZone provides free services like battery and light checks and system diagnostics. It also rents tools to DIYers for individual projects. It's logical that in a recession, customers try to save money, such as forgoing a car repair bill and doing the repairs themselves.

In addition to discount retailers and auto parts retailers, analysts see strong potential at Costco $COST+1.7% and Walmart $WMT+0.8%. The latest data from the National Retail Federation shows that Walmart continues to lead the way as America's top retailer. In 2021, the company achieved U.S. retail sales of $459.51 billion - a 6.6 percent year-over-year increase. However, Costco also fared well, with record sales of $140.06 billion.

Don't forget about economically sensitive stocks in case of a recovery

In a speech in late August, Federal Reserve Chairman Jerome Powell openly warned that the Fed's efforts to curb inflation by aggressively raising interest rates "will bring some pain." So a challenging few months are likely ahead. But once the Fed stops raising interest rates, which most economists expect in early 2023, there could be a rebound in stocks, which are economically sensitive. In this case, analysts say investors should be prepared to buy stocks of economically sensitive retailers.

Hard-assortment retailers, which are sellers of less personal goods such as appliances and electronics, typically suffer from rising interest rates but tend to bounce back from the bottom at the start of an economic recovery. Still, analysts have noted that it is probably too early to buy shares of these retail firms at this time, even though the recession has already begun. Investors should wait to buy shares of cyclical retail companies until the Federal Reserve limits interest rate hikes and when downward earnings revisions turn positive, the analysts noted.

Analysts Lasser, Maheswari and Carden like two cyclical retailers in particular: Target $TGT+0.6% and Home Depot $HD-0.5%. The analysts called these two entities "top ideas" in a note. The same goes for Floor & Decor $FND+1.6%. All of the names have "buy" ratings from UBS. Now we'll take another look at one of the stocks in more detail.

HD stock has taken a ride with the market this year, falling 29%

HD is the largest home improvement retailer by market capitalization, paying a dividend for 35 consecutive years. Currently, Home Depot pays a quarterly dividend of $1.90 per share, representing a 2.75% annual dividend yield. Despite difficult year-over-year comparisons, inflation, and a declining housing market, this strong company continues to grow sales and report earnings. Current economic conditions may yet drain Home Depot and management expects the second half of 2022 to be more challenging than the first half. But despite what happens in the near term, Home Depot is a stellar company with tremendous long-term potential.

If we look at Home Depot's current valuation, its P/E ratio at the time of this writing is approximately 17. For comparison, Home Depot's five-year average P/E ratio is 22.70.

DISCLAIMER: All information presented here is for informational purposes only and is in no way an investment recommendation. Always do your own analysis.

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