Recession-Proof Your Portfolio: 3 Red Flags + 3 Stocks to Buy Now

On the surface, things look pretty great.

Stocks are a couple of percentage points away from all-time highs, the unemployment rate is at 4%, consumer spending remains strong, and inflation is significantly down from the extreme levels a couple of years ago.

In fact, many believe that the Federal Reserve has been able to successfully pull off a ‘soft landing.’ This entails cooling inflation with minimal damage to the economy or the labor market. 

And, falling inflation and a robust economy are the primary factors for the stock market’s strength over the past couple of years.

So far, so good.

But in today’s newsletter, I want to point out some reasons for concern. I’m not saying that the bull market is over or that a recession is imminent. 

Rather that we are entering a different season. Investors should be more mindful of risk and prioritize the safety and stability of their holdings. 

This is where a proven, quantitative system like the Zen Ratings really shines. It allows us to identify the safest and most stable stocks and stay on top of the market’s shifting tides.

(Recently, we unveiled a new screener to help investors identify the most stable and safest stocks in the market. Check it out here.)

Rising Recession Risk

The resilience of the economy and stock market are quite impressive considering that the Fed funds rate has been between 4.5% and 5.5% for most of the past 2 years. 

Typically, such tight monetary policy would stifle economic growth and dampen risk appetites. This hasn’t been the case due to factors like the AI supercycle, trillions of fiscal and monetary stimulus unleashed during Covid, and high levels of household savings.  

These strengths have been enough to offset the drag from higher rates.

However, there’s now increasing evidence that interest-rate sensitive parts of the economy are starting to fray, while the unique factors which insulated the economy from weakness are losing potency. 

For instance, homebuilder stocks have been among the weakest parts of the market in the new year due to high mortgage rates negatively impacting demand. In fact, the S&P 1500 Homebuilders Index is down 25% from its peak in October of last year. Contrast this to a 77% and 25% gain in 2023 and 2024, respectively, when mortgage rates were even higher. 

Previously, homebuilders were able to thrive in a high-rate environment due to a backlog of orders, low levels of available inventory, and shortages in certain parts of the country. Now, the situation is different as evidenced by steep declines in housing starts, mortgage applications, and homebuilder confidence. Further, builders’ margins are starting to erode as well.

A similar story is playing out in other parts of the economy as well:

• Credit card delinquencies sharply increased to 3.1%, the highest levels since 2012.
• Job openings fell to 7.4 million in December 2024, the lowest since January 2021, with 600,000 jobs revised out of 2024 totals. Particular weakness was felt in more cyclical areas like construction and manufacturing. 
• Government spending growth is also expected to flatten in 2025 after rising double-digits in previous years. If DOGE is successful in identifying fraud and enacting cuts, it’s possible that spending could actually decline.
• S&P Global PMI dropped to 50.4 from 52.7, while Caterpillar (CAT) noted weakening demand.
• Commercial real estate remains weak especially in the office segment with a 19.8% vacancy rate. However, pain has not yet been felt due to many loans being refinanced during the pandemic during a period of low rates. There could be a reckoning as $1.5 trillion in loans are maturing in 2025 and will need to be refinanced at higher rates.

The overall takeaway is that rate-sensitive parts of the economy are starting to see more weakness. At the same time, areas of strength, like consumer spending and government, may no longer be strong enough to offset this weakness.

Of course, the economy is always in flux with pockets of strength and weakness. So by no means, does this ensure a recession or a weaker stock market. In fact, some of the strongest stock market environments have coincided with slower economic growth.

Look back to 2018-2019: Trump’s tariff threats rattled markets, the S&P 500 swung wildly, but once the Fed signaled cuts in December 2018, stability returned, and new highs followed by mid-2019. Overall, the S&P 500 finished 31.5% higher in 2019. Today’s Fed pause and tariff talk echo that volatility.

What Thrives in a Downturn 

When the economy weakens, certain segments of the economy prosper and outperform. Traditionally, the best-performing sectors are areas where demand is less elastic, such as consumer staples, utilities, and healthcare. Companies in these sectors also tend to have strong balance sheets and pay dividends which become more valuable when rates do inevitably move lower in response to a weakening economy.

However, recessions also reward businesses that meet urgent needs or exploit scarcity. Pawn Shops like EZCORP (EZPW) and FirstCash (FCFS) shine here: cash-strapped folks trade jewelry for quick loans, a lifeline when banks turn cold. For example, pawn loan demand increased by 15% during the last major recession and period of tight credit conditions in 2008.  Liquidation firms like Liquidity Services (LQDT) thrive too, turning surplus inventory into cash for governments and businesses. 

These businesses aren’t flashy; they are counter-cyclical bets that hum when others stall.

EZCORP Inc. (Nasdaq: EZPW)

EZCORP (EZPW) runs pawn shops across the U.S. and Latin America. In total, the company has more than 1,200 stores. Last year, the company generated $1.1 billion in revenue, primarily from pawn fees and secondhand sales. 

EZPW could also benefit from President Trump’s push towards greater deregulation in the financial sector. Another catalyst is higher gold prices as it means more collateral value for jewelry, leading to bigger loans. 

The company’s last earnings report showed that demand for loans was up 8% on an annual basis with the CEO noting ‘resilient demand’. Overall, the company exceeded analysts’ forecasts for earnings by 7%. Compared to last year, EPS was up 16%, and revenue was 10% higher. The company also upped its forecast for EPS in the upcoming quarter to $0.37 from $0.34.

EZPW is rated an A (Strong Buy) by the Zen Ratings, ranking in the 96th percentile of the 4500+ stocks we track. A-rated stocks have generated an average annual performance of 32.5% over the past 22 years which outclasses the S&P 500’s average annual return of 10.5%. 

To see ISRG’s areas of strength, you can simply turn to the 7 Component Grades within the overall Zen Rating. 

EZPW earns a B rating and is ranked in the top 12% of stocks for Financials  — not surprising given its strong cash position, growth in loan volume, and low levels of debt. The company also has exceeded analysts’ earnings estimates for 14 straight quarters. 

EZPW is also rated a B for Safety, ranking in the top 20% of stocks we track. This is consistent with the company’s strong balance sheet and stability in historical performance, revenue, and earnings. 

It also ranks in the top 13% of stocks and is rated B for Value. Among the 21 Value Factors reviewed, this rating is supported by the company’s low forward P/E of 9.4 which is less than half of the S&P 500’s forward P/E of 22. The company also has $175 million in cash which equates to 25% of its market cap.

FirstCash Holdings, Inc. (Nasdaq: FCFS)

FirstCash (FCFS) is a leading international operator of pawn stores and a provider of technology-driven point-of-sale payment solutions. Currently, it operates more than 3,000 stores in 29 states and several Latin American countries. Its growth has been driven through acquisitions and opening new locations.

The company's business model focuses on two primary segments: pawn lending and retail sales of merchandise acquired through collateral forfeitures and over-the-counter purchases. Like EZPW, it should benefit from a more favorable regulatory environment, higher gold prices, and a weakening economy with acute pain in industries like housing, construction, and manufacturing.

Last year, it had total revenue of $3.4 billion and $287.4 million in net income. Typically, FCFS’ loans average $150 and are between 1 to 3 months of duration. It also sells a wide variety of merchandise including jewelry, electronics, tools, appliances, sporting goods, and musical instruments. A growing segment is American First Finance (AFF) which offers lease-to-own and retail finance payment solutions for over 13,000 merchants. 

In its last quarter, FCFS exceeded analysts’ estimates for earnings and revenue. Additionally, both were up on a double-digit basis from the previous year. Notably, pawn loans outstanding were up by 13% with retail sales climbing by 16%. The company also opened 50 new stores, primarily in Latin America. AFF grew by 20% in the quarter, reaching $210 million in revenue.

Our quant ratings model is also bullish on FCFS. With an overall B (Buy) Zen Rating, it’s in a class of stocks that have produced an annual return of 19.8% since 2003. There’s also strength in its sector as the Credit Services industry is rated an A by the Zen Ratings. 

To get a more holistic perspective of FCFS, you can simply turn to the 7 Component Grades within the overall Zen Rating. 

For Financials, FCFS is rated an A, ranking in the top 5% of stocks we track within this area. This is not surprising given its strong balance sheet, low debt-to-equity ratio, strong earnings momentum, growth rates, and geographical diversity. FCFS has a streak of exceeding analysts’ earnings estimates for 19 straight quarters, even more impressive than EZPW. 

FCFS also enjoys strong support from Wall Street analysts, with 2 Strong Buy ratings with an average consensus forecast of $133, implying 17% upside. Recently, the stock was upgraded by Goldman Sachs which noted its 12% free cash flow yield and ‘recession-proof’ business model. 

Liquidity Services, Inc. (Nasdaq: LQDT)

Liquidity Services (LQDT) is a leading e-commerce marketplace solutions provider that helps government agencies, retailers, and industrial clients efficiently sell surplus assets and inventory. The company operates several online marketplaces, including GovDeals, AllSurplus, and Machinio, where it facilitates the sale of a wide range of products from vehicles and heavy equipment to electronics and apparel.

LQDT's business model focuses on maximizing recovery value for sellers while providing buyers with access to unique and valuable inventory. In fiscal year 2024, the company reported total revenue of $317.2 million and net income of $22.5 million. As the economy slows, LQDT could benefit from increased surplus inventory from businesses and government agencies looking to liquidate assets and reduce costs. Additionally, consumers seeking value in a tighter economic environment may turn to LQDT's marketplaces for discounted goods.

While LQDT’s primary source of revenue is from failing and struggling businesses, it could be a winner from more aggressive government budget cuts. If government agencies face pressure to reduce waste, eliminate unnecessary jobs, and optimize office space, LQDT's GovDeals platform is well-positioned to handle the resulting surge in surplus asset sales, leading to more transaction volume and revenue. 

In its most recent earnings report, LQDT exceeded analysts' expectations for both revenue and earnings. Compared to last year, earnings were up 12%, while revenue was 10% higher. Margins also increased from 52% to 55%. 

The company reported a 5% year-over-year increase in gross merchandise volume (GMV) to $291.7 million, driven by strong performance in its GovDeals and Retail Supply Chain Group segments. Notably, LQDT's Capital Assets Group saw a 12% increase in GMV, reflecting growing demand for industrial equipment and vehicles. 

LQDT’s strong fundamentals are also reflected by the Zen Ratings as the stock is rated an A (Strong Buy). Strong Buy-rated stocks have produced an average annual return of 32.5%.

Momentum is a strong suit for LQDT; it ranks in the 99th percentile of stocks we track based on a review of 22 factors including sub-industry momentum, share turnover, volume-weighted momentum, and more. 

For Sentiment, the stock is rated an A and ranks in the top 5% of stocks we track. Supporting this rating, both analysts we track covering the stock have a Strong Buy rating. They also have a consensus price target of $38.50, implying 15% upside. In addition to Wall Street analysts, the Sentiment rating also reflects a stock’s insider activity, short interest, and earnings revisions.

The stock is also rated a B for Growth. This is consistent with its track-record of double-digit earnings and revenue growth along expansion in gross margins. Unlike many companies, LQDT’s growth prospects should improve if the economy were to weaken.

Check out LQDT’s Component Grades to get even more insight on the company. 

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