Official data released this Wednesday show that the UK has fallen into the deepest recession on record. Investors will likely be wondering what are the best UK shares to buy in a recession. Defensive stocks typically perform relatively well in a recession. However, I think some of the best UK shares to buy in a recession are the ones that might actually outperform when the economy sours.
A significant decline in economic activity that lasts more than a few months defines a recession. UK GDP contracted by 2.2% in the first quarter of 2020 and by a monumental 20.4% in the second. For reference, the worst quarterly decline during the great financial crisis was 2.1%. There are signs of a sharp recovery in the awaited third-quarter results, but this is from a relatively low base.
It will not be a surprise that the coronavirus pandemic has hurt UK businesses. What may be surprising is that UK businesses have been struggling for quite some time. Research from Red Flag Alert indicates that there have been seven consecutive quarters of increasing financial distress among UK businesses, as of the second quarter of this year. Some 527,000 businesses are in financial distress, up 33,000 since the start of 2020. The real estate sector is particularly badly hit, seeing a 19% rise in cases of significant financial distress.
With the recession, the pandemic still not under the control, and Brexit on the horizon, things could continue to get worse. Since stock prices reflect the performance of the underlying business, plenty of share prices could fall.
When the economy is in poor shape, corporate restructuring and insolvency proceedings are in demand. Companies in the the business of corporate restructuring and insolvency, like FRP Advisory Group (LSE: FRP) and Begbies Traynor (LSE: BEG) might actually do well in a recession.
FRP expects to report a 16.4% rise in revenue for 2020 along with bumper profits. Begbies grew its revenue by 17% in 2020 and adjusted pre-tax profits rose by 31%. Both companies are reporting increasing caseloads. This is in spite of financial support for businesses from the UK government and the central bank. Financial difficulties are expected to increase as these supports are withdrawn, leading to more restructuring and insolvency work for FRP and Begbies.
Be warned, however, both of these stocks are AIM-listed. They have small market capitalizations and their share prices could be volatile because the shares are illiquid. Something else to consider is that both these businesses get paid for work done with struggling or bust businesses. Payment can take months to collect, and of course, there is a risk that some fees may not be recovered. Both FRP and Begbies do reflect recovery risk in their financial statements, but assumptions can always be wrong.
But even accounting for the risks, FRP and Begbies do look like some of the best UK shares to buy in a recession to help diversify and protect a portfolio. Both have solid business models that benefit from times of economic uncertainty. If I was choosing just one stock it would be FRP. Begbies has a property division that accounts for about 30% of sales and the real estate sector, as stated earlier, is really struggling.
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James J. McCombie has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.