Have you heard about the Roaring '20s? A hundred years later and they are back to their same games.
As 2021 came to an end, the Gatsbys and the McFly’s along with everyone from Main Street to Wall Street were hoping that this time it would be different and the good times would keep on rolling.
But then, in early 2022 the nightmares of all Tesla owners came true.
Cue ominous music.
The market rally ended abruptly as early telltale recessionary signs began to show.
Now, many are asking, with the risk of recession, what should I do with my money?
Great question when you consider the average investor losses of over 30% of their account value during bear markets.
Since the stock market tends to lead the economy, a recession could already be here.
For RED ZONE investors, timing matters and you will see very soon, that timing a recession is difficult but not impossible.
Over the past 25 years, as money managers, we have been in these waters a few times before and can report that recessions and the bear markets that accompany them have repeatable behaviors and patterns that investors can use to find investable opportunities during and after a recession. That is, if you can avoid taking investment losses during the recession.
How can a RED ZONE Investor (need to use a portion of your money for retirement or healthcare in the next 5-7 years) know a recession is coming and what should they do?
We may start to find some clues by a review of the current market compared to past recessions such as 2008 and 2001.
We are not suggesting a financial crisis is coming. However, due to excess leverage, there are times financial market volatility, and the pain Wall Street feels is much larger than the underlying economic slowdown is for those on Main Street.
We experienced this in 2001 when the Nasqaq declined 70%. However, the related recession during that time was so shallow that most people don't even remember that there was a mild recession at the turn of the century.
This is one example of how Wall Street and Main Street will disconnect in the edgy times of transitional extremes.
Past experience has taught us that when we find ourselves in one of these edgy transitional times that it’s best to go to the charts for some guidance. Past bear markets have shown us that the charts can give us signs before the fundamentals are noticeable to the average investor.
Being ahead of the curve is the best way to take advantage of the opportunities that recessions and bear markets can create for savvy investors and many times the charts can help us start to see those next curves.
As you will observe via this chart of SPY from 2008 shared with us from Real Investment Report that indeed the equity market lead the economy towards recession.
This is a good example and evidence of how the charts like to lead the news.
As you see, the head and shoulders topping chart pattern is evident in the charts from 2008. The break of the rising neckline was the first warning of a recessionary bear market. The subsequent rally to, and failure at, the neckline confirmed the topping process was complete.
We see the same market action in 2022.
Again, we see the topping process, the clear break of the neckline, and a failed test of the neckline, turning it into resistance.
While the market recently bounced on critical support, any failure at the recent lows will confirm a recession, and a bear market is underway. Something we have been pounding the table about for months in our sister publication Market Minutes From The BoardRoom.
Most Importantly - Bonds Are Sharing The Sentiment
Most importantly, bonds are looking to confirm this. Since the turn of the year, bonds have been giving investors of diversified portfolios a rude and cruel awakening.
Falling stock prices and rising interest rates have created an environment where stocks and the bonds investors tend to use as a hedge are acting opposite of normal behavior. Rather than their traditional inverse relationship, both assets have been moving in tandem. This form of “Stagflation” can be detrimental to conservative and even moderate investors as they tend to lose on both sides of their diversification and their accounts become stagnant with losses.
Recently, this out-of-the-ordinary correlation between equities and bonds appears to be changing as investors seem to be starting to accept that the economy could have a "hard landing". As this perception is becoming adopted bonds are starting to give the appearance of once again "working" as a hedge to equities in a portfolio.
Given that there is a large number of institutional investors continuing to bet on higher interest rates and lower bond prices, short positions against bonds that need to be covered could start to put buying pressure that could push bond prices higher and interest rates lower. Something to keep in mind when you are considering future portfolio changes or additions that may have a contrarian view to them.
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So, if the equity and bond market are giving signs that a recession is here.
What does history tell us we can expect?
What should we do if we are a RED ZONE investor that may be retiring in the next 3-7 years and has a desire to preserve and prosper in that timeframe?
A History Of Recessions & Market Responses
Notably, the risk to investors during an economic recession is high.
Historically, markets tend to decline rather sharply during recessionary periods putting investors with sensitive timeframes in jeopardy.
As is evident, economic recessions and bear markets go hand in hand.
The problem with trying to avoid a recession, from an investment perspective, is by the time a recession is evident, it is often too late to change your portfolio.
You Can’t Wait For Them To Ring A Bell And Announce “Hear ye, Hear ye, Thou Recession Shall Commence”
The most considerable risk of investing during a recession is putting a "recession investing strategy" into place at the right time.
The chart below shows the S&P 500 from 1960 to the present. Each blue dot is the market's peak before the onset of a recession. The yellow triangles are the official NBER recession announcements.
The issue to investors is evident. In 9 of 10 instances, the S&P 500 peaked and turned lower before the recognition of a recession.
The decline from the peak was considered “just a correction” as economic growth remained robust. Therefore, investors didn't adjust their strategy to invest during a recession.
In reality, however, the market and the charts were signaling a coming recession in the months ahead. The lagging fundamental economic data didn’t reflect it as of yet.
As you can see the problem for most investors is in waiting for the data to catch up.
As noted in this month's Market Minutes From The BoardRoom, recession investing can be dangerous, particularly when valuations across all asset classes are elevated. However, there are some steps to take to ensure you are prepared to weather increased volatility.
Have excess emergency savings and cash reserves even if this means you harvest some long-term gains. This is so you are not forced to sell during a decline to meet other obligations and the extra cash can be used to buy more investments when the recession is in the rearview and recovery is on the horizon.
If you have incurred losses or declines in your portfolio, focus on recovery. The savviest of investors know losses and drawdowns happen throughout an investment life and when they happen the best use of energy and emotion is to focus on recovery.
Consider organizing the time frame of your assets into buckets and create a new bucket with a 3-7 year time frame and use this bucket to buy distressed or beaten down assets that have the fundamentals to recover or come out of the recession in a stronger competitive position.
Don't obsessively check your portfolio.
Consider alternatives to stocks and bonds. Many investments that are alternatives to stocks and bonds can provide growth and income during times of recession and inflation.
Be thoughtful about your investing discipline and focus on how the timeframe of that discipline aligns with other needs in your life like retirement, health care, or estate succession.
Considering those points.
What investments do well in a recession?
A recession is a good time to avoid speculating too much too soon. Especially on stocks that went public in the later stages of the bull market. These would-be stocks went public after 2018.
Weaker companies with high valuations tend to go bankrupt during recessions. It is important to remember while stocks that have fallen by 80% might seem like a bargain, they are probably cheap for a reason.
To make money from a recession RED ZONE investors will be better served to focus on companies that:
Have consistent earnings growth over time and are solving a problem or providing a service you can see has a secular growth story behind it.
Are dividend-payers and avoid high leverage. Look for the “Aristocrats” that are consistent at increasing their dividend.
Have free cash flow, strong operating margins, and benefit from a secular trend.
Avoid companies dependent on consumer spending, or investor money and have high cash burn rates or have negative incomes and earnings.
Invest incrementally and build a position over time.
Don't forget about bonds. Recessions create opportunities in both Corporate and Government Bonds that you can’t find in any other time of investing.
Lastly, know your alternatives. Some alternative investments can be growth replacements to stocks during and after a recession.
Investing during a recession is not easy due to high volatility, falling prices, and negative media headlines. However, it can be very profitable given a well-thought-out strategy under the right circumstances.
Do you desire to preserve the gains of the past few years? Do you need to keep your portfolio growing and producing income even during a recession? Are you frustrated with recent declines in your portfolio?
There are strategic actions we can take to protect your portfolio in a recession.