Peter Hodson: You can still make money, even in a bad recession
A crosswalk sign flashes red in Toronto’s financial district. Photo by Cole Burston/Bloomberg In case you hadn’t heard, there is a recession coming. Like in a movie where the demon is just around the corner, investors are scared, not knowing what is coming to eat their portfolios. The result? Investors sell ahead of time, which is occurring now. It doesn’t matter that nothing in the markets is ever guaranteed, and investors/analysts have predicted 80 of the past seven recessions, investors just want out, and are pretty much selling everything, as you’ve no doubt noticed recently.
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We think that’s wrong. For one point, most modern recessions are very short. We might be talking three quarters or so. Do you really want to change your entire portfolio for what might be a less-than-one-year event? Aren’t you supposed to be investing for the long term? Two, recessions get priced in ahead of time. Most investors sell when news is bad, and of course it is bad in a recession. But when all the news is bad, the odds of something good happening increase. Markets can rally hard in the face of bad news (sometimes). Three, most recessions start with job losses. In North America, finding workers is a bigger problem right now. Everyone, it seems, is hiring. Sure, this can add to inflationary wage pressures, but hardly sets up an economic disaster. Four, as noted above, analysts are always predicting a recession, but they don’t always occur. How are stocks going to do if corporate earnings are much better than everyone expects?
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But, suppose you truly, firmly believe there is going to be a bad recession. Surprise! You can still make money. Let’s take a look at five strategies that might work if we do encounter the R-word.
Buy preferred shares In a recession, investors get scared, and when investors get scared, they seek safety. Preferred shares, as the name implies, get a preferred ranking in terms of investor protection. Preferred dividends take priority over common share dividends. In a company break-up, preferred shares get priority treatment, after bonds. Thus, investors see, rightly so, that preferred shares are “safer” in times of economic trouble. Worried about common dividends being cut? Preferred shares are less likely to be cancelled. Now, don’t get us wrong, preferred shares can still decline, as anyone in the sector surely knows from the horrible 2017 to 2019 experience. But they are certainly more secure than common shares, and can get a bid when investors are seeking safety over all other metrics. Preferreds can also benefit from falling interest rates (as explained below in bonds).
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Article content Buy bonds In a typical recession, central banks around the world try to stimulate their economies in order to get growth back on track. One way to do this is to lower interest rates. Now, in this cycle this might take longer, as the fight against inflation remains, for now, more important to the powers-that-be. But at some point, interest rates will peak, and then possibly decline. In this scenario, bonds can do very well. Long-term bonds can do exceptionally well, as they are more levered to interest rate movements. The bond market has been absolutely crushed in the past year, and investors worldwide are wondering why they own any bonds in the first place. But under a different economic picture, bonds can do very well, and can certainly outperform stocks for a while. In addition, of course, corporate bonds rank higher than common stocks, and preferred shares, so buying bonds moves you up on the investment safety scale. Government bonds are guaranteed, at least as far as interest and principal, so are even safer, overall. They can be a good place to hide during a recession.
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Article content Buy growth stocks (no, really) Many growth stocks are down 70 per cent, or more, this year alone. In a recession, however, investors worry about growth. Those companies that can still grow fast can get a lot more attention if everything else is in decline. Growth stocks also have leverage to interest rates, and can move quickly when rates decline. Many growth stocks have high margins, and their businesses do not necessarily decline in a recession (think of sectors such as automation and cybersecurity, where investments tend to continue regardless of the economy). So, while everyone is selling growth, smart investors might consider chipping away at buying some of the quality stocks (babies) being thrown out with the recession (bathwater).
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Article content Five daily affirmations to get investors through this latest bear market Five of the stranger things happening in the market these days Five strategies to help you cope with a growling bear market Welcome to The Upside Down market, where strange things are the norm Dollar-cost average But we need to face reality, here, and yes, stocks can decline in a recession, sometimes by a lot. But you don’t know when the recession will end, and neither do I. No one rings a bell at the bottom. So, what to do? In a market decline, dollar-cost averaging is often a good strategy. Say you have $10,000 to invest. Investing $1,000 per month for ten months as the market reacts to a weak economy is probably going to work out well, given enough time. Keep an eye on commission costs, of course, but these days with some free commission companies this is less of an issue. You won’t get the exact bottom, of course, but your average price over ten months to a year will likely look pretty good in 2024, or even sooner, depending on how this economy plays itself out.
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Article content Buy health care If investors want to get specific in their recession planning, there are some sectors that can do well, or at least less bad, during rougher economic times. Market sectors that tend to hold up better are consumer staples (people gotta eat!), utilities (don’t cut off my electricity!) and communications (I still need my phone to look for a job!). Health care is another sector we like. Simply put, if you are taking medicine for a health issue, you don’t care if there is a recession. Your house value and stock portfolio could go to zero, but you are still going to buy those drugs that keep you alive. iShares US Healthcare ETF (symbol IYH) might be a consideration for investors in this theme.
Article content Peter Hodson, CFA, is founder and head of Research at 5i Research Inc., an independent investment research network helping do-it-yourself investors reach their investment goals. He is also portfolio manager for the i2i Long/Short U.S. Equity Fund. (5i Research staff do not own Canadian stocks. i2i Long/Short Fund may own non-Canadian stocks mentioned.)
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