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8 of the Best Investments During an Economic Slowdown

Debbie Carlson

Investing in a late-cycle market can be tricky.

The stock market is jittery over worries about an economic slowdown, and August's inverted yield curve added to those concerns. The stock market's bull run is at 10 years-plus and many analysts think the market is closer to the end of its cycle than the beginning. Investing in a late-cycle market can be tricky because current trends can keep going, but there are clues that trends may be turning. Chris Cook, president of Beacon Capital Management, says he watches if the broader market falls by 10% or more from its high. That's a sign momentum may be changing, ratcheting up the odds of a recession or a bear market, he adds. Here are eight of the best investments for late-cycle investing.

Equal-weight all sectors

Late-market cycles can last longer than expected, as it's hard to tell when it ends. "We're going through that now," Cook says. If investors are concerned, they can rebalance their asset allocation equally across all sectors. "If you equally allocate that way, you're going to participate while the market continues to move up. But that equal allocation will be more conservative than what your traditional core holdings would be," he adds. An equal-weight allocation boosts defensive sectors and lowers growth sectors. Some exchange-traded funds take this approach, such as the Invesco S&P 500 Equal Weight ETF (ticker: RSP).

Utilities stocks

Utilities are considered the classic defensive sector as they are made up of staid, slow-growing companies that usually pay higher dividends to attract investors. Cook says with the Federal Reserve cutting interest rates, it makes sense for conservative investors to seek a higher weighting in this sector since utilities will be less subject to interest rate risk. Investors have a few options if they want to add utilities exposure to their portfolio. At this writing, U.S. News & World Report ranks Fidelity MSCI Utilities ETF (FUTY) as the best utilities ETF, with an expense ratio of 0.08% and a 17.9% year-to-date return. The top-ranked utilities mutual fund by U.S. News & World Report is Vanguard Utilities Index Fund (VUIAX), up 17% in 2019.

Consumer staples

Another defensive sector, consumer staples are products that people use every day -- coffee, paper towels and other non-glamorous products. Because these items are in our households on a constant basis, consumer-staples companies will often hold their value better if investors think a recession is around the corner, Cook says. "A company like Procter & Gamble (PG) makes the products people are always going to buy: the soaps, toothpaste, diapers," he says as an example. Vanguard's Consumer Staples ETF (VDC) is U.S. News's top-ranked consumer defensive ETF.

Health care

David Yepez, senior investment analyst at Exencial Wealth Advisors, says health care is another area of safety in a late-cycle environment. Like other defensive sectors, people usually don't stop completely using health care in a recession, so it is less macroeconomically sensitive. Yepez says he likes the medical devices subsector, and there his choice is Baxter International (BAX). He says the CEO, Jose Almeida, has helped to turn around the company, and Yepez especially likes the research they are doing to help people with kidney problems. Baxter is the No. 1 player in home dialysis and he sees further growth in this area. ETF investors can look into iShares U.S. Medical Devices ETF (IHI), the biggest of two ETFs focused on this health care subsector. It is up 20% year-to-date.

Real estate

Tom Essaye, editor of the Sevens Report newsletter, says he favors being conservative with tactical investments at this time. Real estate can be a solid holding in the current economic cycle, especially after the Fed's interest rate cut. "Real estate remains a perfect candidate for this environment given falling yields, a strong labor market and rising wages," he says. He points to the Real Estate Select Sector SPDR ETF (XLRE) as one option. In U.S. News's real estate ETF rankings, the Fidelity MSCI Real Estate ETF (FREL) is No. 1. It has an expense ratio of 0.084% and is up 22% year-to-date.

Value-focused ETF and mutual funds

Growth-focused stocks, ETFs and mutual funds have dominated this bull market, and Dave Alison, certified financial planner at Clarity 2 Prosperity, says in a downturn, value investments may get the upper hand. There are two reasons. One is a reversion to mean. Since growth has outperformed value, a change in the economic cycle could allow value to rebound. Second, in recessions, companies with strong balance sheets handle the tough times better. Alison says he is shifting his clients' portfolio to have a value tilt by using diversified funds. For retail investors not working with a financial advisor, he recommends an inexpensive broad-based diversified value fund. Two examples are iShares Edge MSCI USA Value Factor ETF (VLUE) and the Edgar Lomax Value Fund (LOMAX), a mutual fund.

Small-cap stocks

Small-cap stocks have underperformed large-cap stocks. On the idea of investments returning to mean, Alison says in this late cycle, small caps may begin to rebound. Also, historically, small caps outperform large caps. which may set up investors for future growth. Alison says his firm is buying global small-cap funds because international markets did not keep up with the U.S. in the past 10 years, so there are more bargains there. "Now could be a time where if you've been heavily investing in the U.S. and you're worried (about markets here), global diversification could be a good move at this point," he says. One of the biggest ETFs by assets under management in the foreign small-cap segment is WisdomTree International SmallCap Dividend Index, with $1.5 billion in assets.

U.S. Treasurys

Cook says for investors really concerned about a falling stock market or worries that a recession is around the corner, rather than go into a cash position, he prefers the safety of U.S. Treasury notes. But he says he only does this when the broader stock market drops 10% or more from its high. "That's a cue for me that we're starting to gain momentum on the wrong side," he says. If the Fed lowers rates again to spur the economy, then buyers will benefit further, he adds. He opts for the intermediate part of the yield curve, known as the belly of curve, with five to seven years remaining to maturity. A close mutual fund example is the Vanguard Intermediate-Term Fund (VFITX) which invests at least 80% of its assets in U.S. Treasury securities and seeks to hold a dollar-weighted maturity of five to 10 years. Vanguard's ETF version is Vanguard Intermediate-Term Treasury ETF (VGIT).

The best investments in a recession:

-- Equal-weight all sectors

-- Utilities stocks

-- Consumer staples

-- Health care

-- Real estate

-- Value-focused ETF and mutual funds

-- Small-cap stocks

-- U.S. Treasurys

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