Market Watch : All Is Risky in a Recession

Oil and gold stocks have led the market since the Mideast crisis began. But some investors have also rushed into so-called defensive stocks: food, drug, beverage and tobacco issues. The conventional wisdom is that those companies' businesses are recession-resistant and, therefore, the stocks should perform well no matter what happens.

Defensiveness, however, only goes so far. Although some buyers surfaced last week to bolster such stocks as Philip Morris, Coca-Cola and Eli Lilly, it wasn't enough to keep many from losing ground. Philip Morris fell 62.5 cents for the week, to $45.875 Friday. Lilly lost $4.75 to $75.25. Many may have lost less than the market, in percentage terms, but they fell nonetheless.

Could these stocks rise by year-end even if a hard recession hits? Doubtful, many experts say. A recession probably would take virtually all stocks lower, at least temporarily. A look at the 1974 recession, for example, shows that only seven of 100-plus stock industry groups rose in that year.

The Standard & Poor's 500-stock index tumbled 30% in 1974. As might be expected, the stock groups hurt the most included real estate and hotels. But surprisingly, some classic defensive stocks also were among the worst hit, including soft drinks, brewers and pollution control.

What happened to those stocks? Their sharp declines partly stemmed from investors' change of mind regarding the "Nifty Fifty" stocks--growth stocks that had been expected to grow to the moon. Many of those stocks had sold for price-to-earnings ratios of 40, 50 or more in 1973. The 1974 bear market took the air out of those P/E ratios, and then some.

At the same time, defensive stocks in the food and drug industries did indeed perform better than the market in 1974. Still, they too lost ground. The average food stock dropped 17.9%. The average drug stock lost 19.8%.

What would happen in a recession this time? Arnold Kaufman, editor of S&P;'s Outlook newsletter, warns that because food and drug stocks sell for well above-market P/E ratios today, "Some of those stocks have lost some of their defensive characteristics." What's more, he notes that if inflation were to zoom again, food companies could be caught in a bind, potentially forced to pay more for grain, meat and other commodities.

Of course, history rarely repeats exactly. And the factors that influenced stock prices in the 1974 recession aren't necessarily the same ones that would influence prices today. The lesson here is simply not to bet blindly on any so-called defensive group. Your best strategy, if bargain hunting today, is to buy only the stocks that you'd be comfortable holding for the long term.

Oh, yes; the best stock group to have owned in 1974 was sugar beet refiners. The average stock in that group jumped 99.4% for the year. Unfortunately, the group no longer exists.

Why Are These Traders Smiling? When stock prices drop, the only people who make money are those who had bet that way: the short-sellers. So the latest market turmoil puts the spotlight back on the shorts. But the fact is, making money isn't a new theme for the shorts. Many say they've been doing very well all year, even when the market was rallying.

How could that be? Easy: For as many stocks as were going up this year, plenty were going down. It's another sign of the sea change in the stock market for the 1990s. In the bull market of the '80s, everything seemed to rise. But the '90s have seen the return of the stock picker. You can't just buy anything. You've got to do your homework and buy the companies that will perform.

From the short-sellers' point of view, stock picking works both ways. If you can identify the stocks that are likely to disappoint Wall Street, you can make money off those stocks' swift declines. In a short sale, a trader borrows stock and sells it, betting that the market price will drop. If that happens, the trader repays the borrowed shares with new stock bought at a lower price. For example, if you sell short at $60 a share and the stock falls to $40, you make $20.

If you bet wrong, you can get killed. So this isn't a game for the meek. It also runs against many Americans' basic investing instinct, which is to be optimistic about stocks rather than pessimistic. Still, in a stock picker's market, it's a strategy that sophisticated traders are likely to use more and more in the '90s.

California is home to some of the best-known shorts. The Feshbach brothers of Palo Alto are among the trade's kingpins. Joe Feshbach says his short portfolio is up 40% for the year. It was up 23% in the first six months, even as the market rose.

Feshbach believes that "we're already in a recession," so he sees plenty of overvalued stocks that should drop further. "We're still short lots of banks and financial services companies," he says. "We've been printing money there" as the stocks have tumbled.

Some brokers say short-selling doesn't deserve its evil, gun-slinging image. Ken Luskin, a Paine Webber stockbroker in downtown Los Angeles, uses short sales as a hedge strategy for some business-owner clients. If a client sees his business beginning to suffer from the economic slowdown, Luskin may recommend shorting stocks of public companies in the same field. That, at least, gives the client a way to profit from the slowdown.


These stock industry groups performed worst in the 1974 bear market, when the S&P; 500 index plunged 30%. Group: 1974 change Real estate trusts: -79% Steam generating: -72% Brewers: -72% Pollution control: -69% Soft drinks: -55% Hotel/motel: -55% Offshore drilling: -54% Real estate: -53% Restaurants: -52% Air conditioning: -50%

Source: Standard & Poor's

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