How To Invest For The Next Recession

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Stock-market losses during a recession can be jarring.

If defaults, layoffs or bad economic data give markets a whiff of recession, stocks could sell off rapidly, with little spared as investors shed risky assets for safer ones. “There are very few places to hide in a bear market,” says Sam Stovall of CFRA. “Once you scream bear market, everything goes red except for bonds, the U.S. dollar and most times, gold.” So-called defensive sectors such as consumer staples and utilities tend to hold up better than most other sectors—but they still drop. Since 1945, bear-market declines have averaged double-digits in every sector, according to CFRA.


See what’s likely to cause the next recession.


The riskiest and safest investments in a recession

PIMCO thinks the riskiest investments during the next recession include companies with high-yield or junk-rated debt, which will be most vulnerable to default as credit tightens. Safer: Short-term bonds such as highly rated corporates or US Treasuries. PIMCO also thinks tougher regulation during the last decade could shield industries that were highly vulnerable the last time around. “Sectors that have seen a significant increase in regulation, including commercial real estate and the financial sector as well as housing, will likely demonstrate resilience,” PIMCO analysts wrote in a recent report.

Cash is perhaps the most obvious place to put your money during a bear market, since it protects your principal and leaves “dry powder” for buying when you feel the bear market may be close to a bottom. But there are risks with cash, too. First, nobody knows when the next recession will start and end, so you could miss out on market gains by liquidating too soon—or get crushed by liquidating too late. And while your money’s in cash, you’re still losing out to inflation.

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Every category of stocks suffers losses during a bear market, even “defensive” sectors.

As for gold, its reputation as a store of value in chaotic times is not quite correct. Gold prices, for instance, fell by about 25% during the first couple months of the financial crash in 2008. Gold recovered faster than the stock market did after that, but it still subjected holders to a nauseating, if brief, nosedive. Exchange-traded funds based on the price of gold, such as SPDR Gold Shares (GLD), performed similarly.

Investing pros typically recommend a blend of assets split among riskier stocks, safer bonds, cash and precious metals, based on your risk profile. In a bear market environment, it’s obviously prudent to shift your mix away from risk in favor of safety. But timing is everything, and the old maxim—don’t try to time the market—applies in both good times and bad.

One way to mitigate timing risk is to move money out of riskier assets into safer ones on a consistent schedule that’s not influenced by market movements, similar to the dollar-cost averaging strategy—but in reverse. “Every month, take out a portion of your cyclical investments and place them into more defensive areas like consumer staples, utilities, cash, and gold,” says Stovall.

Boring bonds

Peter Kenny, co-founder of market analytics firm Kenny & Company, suggests harvesting profits from investments that have treated you best. “Take some money off the table, especially in funds or equities that have given you outperformance,” he says. “If you’re up 100%, take 50% off the table. It’s going to feel counterintuitive. That’s why so many people get hung up on this. They’ve made money and they love looking at that symbol. That attachment should never be tolerated.”

Brokerages such as Vanguard, Fidelity, Schwab and Ameritrade offer a variety of mutual and exchange-traded bond funds that provide the type of haven many investors seek during a bear market. A short-term bond fund holding high-quality securities tends to be safest. “Short-term bond funds tend to be safer, because the range of yields in a short-term fund is much smaller,” says Karen Wallace, a senior editor at Morningstar. “They’ll probably yield a little bit more than cash.” Still, keep in mind: bond funds can lose money.

One strategy is to gradually move money into a fund that tracks the Bloomberg Barclays US aggregate bond index, a group of highly rated government and corporate bonds. The Barclays “agg,” as its known, did fall in value for short periods of time during the 2008 financial shock. But overall, it rose 6.8% in 2007, 4.3% in 2008 and 6.4% in 2009. The S&P 500, by comparison, rose 3.5% in 2007, plunged 38.5% in 2008 and recovered 23.4% in 2009. The boring bond fund insured against panic.

So if you do survive the next recession with principal intact, when should you start to bargain-shop? And for what? The answer, again, depends largely on each investor’s ability to tolerate risk. But trading patterns during prior recoveries provide guidance.

“The recovery is the mirror image of the decline,” says Stovall. “Cyclicals tend to do best because they did the worst on the way down.” He also points out that markets tend to recover very quickly once investors think the bottom is near, with everybody trying to grab bargains. “In the first 40 days of a new bull market, we tend to recover 25% of what we lost in the entire bear market.”

It’s hard to overstate the difficulty of timing the market, and guessing when the recession is likely to end. Investors thought they were out of the woods when a short recession and bear market ended in the middle of 1980, for instance – but a new recession started a year later, with stocks falling further, for longer, during the second downturn. So shifting from safer assets to riskier ones, if that’s the way you choose to go, is best done incrementally on a consistent schedule.

There may be bargains other than stocks as the next recession comes and goes. Home values have been rising steadily since 2012, and are now at new record highs, leaving many buyers priced out. But home values often fall during a recession—which could be just the break home buyers are looking for. “It may be an opportunity for a younger generation that has been completely unable to access the housing market,” says Peter Kenny. We’ll have more on that in a future installment of this series. Until then, protect your principal.

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Rick Newman is the author of four books, including “ > Rebounders: How Winners Pivot from Setback to Success

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Thanks you for read my article How To Invest For The Next Recession
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