Three ways to recession-proof your portfolio

Recession Protection

Worried about the market crashing? Here are three principles of protecting your investments against a recession.

In case you haven’t noticed, UK economic performance has been running at sub-par levels since 2018. In the last quarter, the British economy was the weakest among G7 nations, with a dismal -0.2% (see below).

More worryingly, one more quarter of weak performance will send UK into a ‘technical recession‘.

Today (27 Sept), even one of Bank of England’s MPC members warned that, because of Brexit uncertainties and weak global growth, ‘I think it is quite plausible that the next move in Bank Rate would be down rather than up.’ 

In fact, given the drumbeat of negative economic statistics you wonder: Has the recession started already?

Source: the Guardian

Here’s How You Should Plan For An Imminent Recession

The plan should start now. You should be prepared as the Brexit-wounded economy moves into an uncharted territory. But to enact a plan as crucial as this requires some thinking. How should you navigate?

To get to the gist of the plan, I show you three principles that underpin it. These principles are very important because they create mini-plans which you can follow easily.

The three principles of protecting against a recession are:

  1. Cash is king during a recession
  2. Economic performance does not rhyme exactly with the stock market performance
  3. Quality matters

Principle 1: Cash is king during a recession

In a recession, nothing beats cash (or cash-generating assets). Why? Because it gives you two important strategic edges. One is the ability to survive the downturn without having to sell assets at fire-sale levels and two, resources to buy assets at attractive prices.

Survival for the long term is what counts. Remember Warren Buffett’s advice: ‘In order to finish first, you must first finish.’ Cash give you the ability to do that.

The second edge of cash – buy assets at attractive prices – gives you outstanding performances over the long term. As Shelby Davis pointed out: “You make most of your money in a bear market, you just don’t realize it at the time.”

Remember what Warren Buffett did in 2008? He went in big and loaded up. Even before the recession had ended, his paper profits were in the millions. How was he able to do that? Because he had cash. Lots of it.

So take a look at your portfolio now and see if some stock sales may be warranted. The current bull market is already ten-year old. Accumulate a strategic amount for bargain buying.

Principle 2: Economic Performance is not the same as Stock Performance

An economic recession, especially if it is a shallow one, may not lead to a sustained bear market.

Economic and stock performances are two different things. Sometimes they move together; sometime they are out of sync with one another. For example, while UK economic performance fared poorly this year, the FTSE 100 Index did better.

In the seventies, for example, the US economy was performing but the stock market did not.

Based on this principle, how do you translate it into a working tactic? For one, avoid major market timing exercise. Second, be patient on the sale and purchase of stocks.

The stock market is not going to tell you when the bull market has ended. Neither does it warn you that a bear market has started. Very few bought at the exact lows; or sold at the very peak. So market timing in this sense will be futile.

Thus, if you wish to implement some stock sales, do so on a regularly basis. Spread out your purchases over time and avoid  cramming all the buying and selling at a single point.

Principle 3: Quality Matters

The last principle is about quality. If you have a portfolio of stocks, how should you determine which one to hold and which one to sell?

In a downturn, go for quality. For two reasons. First, quality corporations are far more likely to survive a downturn than weak ones. Two, quality stocks generally exhibit better relative strength during a bear market.

Relative strength is about its performance measured against the general market. You typically want to hold a stock that is outperforming the general market.

Another factor to consider is dividend. Dividend is very important because it will provide you with some financial cushion when prices are falling – returns that allow you buy more of that stock at better prices.

And quality firms tend to pay a dividend during a recession because they have lower leverage, higher profitability, and good cash flow.

But which companies will pay a dividend during a recession? Take a look at the last recession. One sector that is generally defensive and quality are large-cap pharmaceutical stocks.

During a bear market, small-cap stocks are generally undercapitalised and may be hit harder by the recession. For example, according to Financial Times, only one-fifth of smaller firms are prepared for a no-deal Brexit. I suspect this is due to inadequate resources. If you hold small-cap stocks, make sure these stocks have sound balance sheets.

Other quality assets that you may go for include:

  • Gold – which hold up relatively well during a downturn
  • Government Bonds – haven asset during a crisis
  • Quality Corporate Bonds 
  • Quality Emerging Stocks – Some EM stocks are high quality that are worth buying when prices decline

However, a lot of these assets have already rallied significantly this year. Therefore, even if I were buy these assets, I would use Principle 2 – buying a portion of these assets over time.

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