How Recessions Impact Corporate Fundamentals and Dividend Strategies

How Recessions Impact Corporate Fundamentals and Dividend Strategies

The Impact of Recessions on Corporate Balance Sheets

Recessions, often characterized by a contraction in credit and financial markets, can significantly impact corporate balance sheets. The St. Louis Fed’s Financial Stress Index (STLFSI3), based on 18 weekly data series including interest rates, yield spreads, and other indicators, measures financial stress in the markets. A value above zero on this index indicates above-average financial stress. Recent readings suggest low financial stress in current market conditions.

The Chicago Fed’s National Financial Conditions Index (NFCI) and its adjusted version (ANFCI) also provide insight into U.S. financial conditions through 105 financial activity measures. These indices, which factor in risk, credit, and leverage, along with macroeconomic conditions, suggest a stable state of the country’s financial system and corporate balance sheets.

In times of recession, it’s crucial for companies to maintain strong balance sheets. This is evident during periods of increased financial stress and tightening credit conditions, as corporate bond yields, particularly for higher-risk bonds, tend to rise. The likelihood of bankruptcy varies with credit ratings, ranging from 0.07% for AAA-rated entities to 100% for those rated D.

Credit Rating30-Year Bankruptcy Probability
AAA0.07%
AA+0.29%
AA0.51%
AA-0.55%
A+0.60%
A0.66%
A- 2.5%
BBB+5%
BBB7.5%
BBB- Investment Grade Cutoff11%
BB+14%
BB17%
BB-21%
B+25%
B37%
B-45%
CCC+52%
CCC59%
CCC-65%
CC70%
C80%
D100%

It’s observed that during recessions, fundamentals such as corporate sales, earnings, and dividends tend to decline, emphasizing the importance of financial resilience. Overall, the analysis indicates that companies with robust balance sheets are better positioned to weather the challenges posed by economic downturns.

The Effect of Recessions on Corporate Fundamentals

An examination of corporate fundamentals during past recessions since WWII reveals varying degrees of impact on sales, earnings, dividends, and price-to-earnings ratios. On average, sales decline by about 5.4%, earnings by 14.9%, and dividends by 1.8%, with a 20.4% change in P/E ratios. However, excluding the Great Recession and the pandemic, these figures show a slightly less pronounced impact.

S&P Fundamentals During Recessions 

RecessionS&P Sales DeclineS&P EPS DeclineS&P Dividend DeclineS&P PE Compression
1945NA-6.5%-8.9%33.6%
1948NA3.4%25.1%-26.6%
1953NA11.2%7.0%-7.1%
1957NA-15.7%-3.9%-6.4%
1960NA-3.1%2.9%8.6%
1969NA-15.9%-5.9%-10.7%
1973NA-18.8%-9.4%-54.1%
1980NA-4.8%-1.2%22.1%
1981NA-20.8%-0.2%-14.3%
1990NA-27.4%-2.0%1.5%
2001-1.2%-51.4%-5.7%-16.3%
2007-11.4%-30.3%-19.5%308.5%
2020-3.7%-14.1%-2.0%26.9%
Average-5.4%-14.9%-1.8%20.4%
Median-3.7%-15.7%-2.0%-6.4%
Max-1.2%11.2%25.1%308.5%
Min-11.4%-51.4%-19.5%-54.1%

Recessions typically last about 10 to 11 months, with corporate fundamentals often recovering quickly in the following year. The recovery phase usually sees a rebound in sales, earnings, dividends, and P/E ratios, demonstrating the resilience of corporate fundamentals post-recession.

Recession Start DateRecession End DateRecession Duration (Days)
2/28/194510/31/1945245
11/30/194810/31/1949335
7/31/19535/31/1954304
8/31/19574/30/1958242
4/30/19602/28/1961304
12/31/196911/30/1970334
11/30/19733/31/1975486
1/31/19807/31/1980182
7/31/198111/30/1982487
7/31/19903/31/1991243
3/31/200111/30/2001244
12/31/20079/30/2009639
3/1/20205/1/202061
Average315.8
Median304.0
Max639
Min61

The historical performance of U.S. corporations, particularly in terms of dividend growth, highlights their potential as a hedge against inflation. Inflation-adjusted dividend growth has shown a steady increase over various time frames, underlining the capacity of these corporations to adapt and grow even in fluctuating economic conditions.

S&P Fundamentals Following Recessions

RecessionS&P Next Year Sales RecoveryS&P Next Year Earnings RecoveryS&P Next Year Dividend RecoveryS&P Next Year PE Recovery
1945NA40%9%-30%
1948NA16%22%9%
1953NA30%6%24%
1957NA15%3%50%
1960NA14%4%14%
1969NA8%-5%15%
1973NA19%5%42%
1980NA-21%0%-14%
1981NA7%-1%49%
1990NA16%-1%69%
20011%9%-5%68%
20076%40%3%-71%
202011%50%6%45%
Average6.0%18.6%3.5%20.8%
Median6.0%15.6%3.0%24.5%
Max10.9%50.0%21.8%68.9%
Min1.2%-20.8%-5.3%-70.8%

Strategies for Recession-Resistant Diversified Blue-Chip Portfolios

In economic downturns, prudently managed, diversified portfolios can offer significant resilience. A key strategy is to select high-quality companies across various sectors, focusing on strong balance sheets and solid credit ratings. This approach aims to minimize risk and optimize returns even during market volatility.

For instance, constructing a portfolio with top-rated companies in each sector can lead to a well-diversified, high-quality investment pool. Such portfolios have historically shown robustness during recessions, with lower declines in value compared to broader market averages. These portfolios typically include companies with stable credit ratings and low bankruptcy risks, indicating strong financial health.

An example of a portfolio with highly diversified/high quality companies:

CompanyQuality Score (Out Of 100)Safety Score (Out Of 100)S&P Credit RatingCredit Rating Outlook30-Year Bankruptcy RiskDividend Growth Streak (Years)
Lowe’s100%100%BBB+Stable5.00%59
Mastercard100%100%A+Stable0.60%10
Colgate-Palmolive99%100%AA-Stable0.55%59
Novartis97%100%AA-Stable0.55%25
Allianz SE96%97%AAStable0.55%2
Carlisle Companies96%95%BBBStable7.50%45
Alphabet95%100%AA+Stable0.29%NA
PPG Industries90%92%BBB+Stable5.00%50
Enbridge89%88%BBB+Stable5.00%27
Realty Income85%89%A-Stable2.50%27
UGI Corp83%88%NAStable13.00%34
Average93.6%95.4%A-Stable3.69%33.8

The efficacy of this strategy is further evidenced by various financial metrics, including dividend growth streaks and safety scores. A well-curated selection of companies tends to exhibit consistent dividend growth, further reinforcing the portfolio’s stability.

In summary, by focusing on high-quality, diversified investments, investors can build portfolios that not only withstand economic downturns but also recover and grow post-recession. This approach underscores the importance of quality and diversification in long-term investment planning.

We have started building a high-quality, highly diversified portfolio in April 2023. This portfolio is aimed at achieving financial freedom and includes ETFs, stocks, bonds and managed futures. We have been investing on it $500/weekly (but readers can start with as low as $100/week using apps like Robinhood that allow to buy fractional shares from $1). Every week the $500 investment is tailored based on the price of the equities in the week before, so we can always buy at the best value. In the coming weeks, as we build the Financial Section of the website we will share this portfolio and others with our readers, so you can easily follow along and start building your financial freedom and happy retirement!

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