We have been in recession for more than a year and it is still not clear if the economic shocks are done coming. The recession may last for another year or more depending on if and when the government actions start stimulating the economy. Traditional Buy and Hold strategies call for buying when the stock prices are low. But during recession equities can remain depressed for years at end. This is a right time to reconsider your investing strategy to position your portfolio to weather the recession. Additionally, we would want to consider stocks and investments that can do well in an inflationary environment. All the trillions of dollars that are now being pumped into the economy in the name of stimulus and bailouts, will have significant inflationary effect in the near future.
What Stocks Should we Consider?
Recession is defined as a period when the economic activity of the country is declining. Which means, that in most sectors of the economy, the inventories are high and capacity to build far exceeds demand. This includes once hot sectors such as high technology and housing. The reasons for demand/supply imbalance could be many; overbuilding due to loose credit for non-essential purchases was the main reason for the current recession, rapidly declining purchasing power may be another reason which is also manifesting itself in the economy today. Recession stocks are stocks of the companies that typically do not have such demand/supply imbalance. This is mainly because they produce goods or services that are essential for consumers, and these goods and services are very price inelastic (meaning consumer demand does not change much if the price changes up or down).
So what are these companies? These companies include sectors of consumer staples (like tooth paste, shampoo, soap, etc), drugs, vice (tobacco), etc. You may also consider companies that do work for the government like defence suppliers, prison management, etc. Many of these companies do steady and boring business with no surprise growth spurts but also no surprise declines. These are some of the sectors you should consider investing in. Respectable dividends are also an added benefit that many companies in these sectors can offer. You can do more research on companies in these sectors using Yahoo Finance or Google if you want to construct your stocks portfolio.
Investing Strategy for coming high inflation
If you are also worried about high inflation in the future, as I am, there are a few investments that you can consider. Keep in mind that a period of high inflation will almost surely decimate the purchasing power of an cash or cash like investments (CDs, money markets, treasuries) that you may have. The only way to keep up with the inflation is to invest in TIPS or to invest in stocks. But which stocks?
The key to figuring this out is to understand that the rise in inflation is going to be due to the freer monetary policy and the countless trillions that are being pumped into the US economy today in the name of stimulus. Similar actions are being taken in Europe and other countries, although, arguably to a lesser degree. High inflation means the value of the dollar will decline rapidly in real terms and also as measured against some other currencies and commodities. So how should we change our investing strategy to protect against this?
Hard assets provide some protection against inflation as they become more valuable as inflation goes up. I do not recommend buying gold, although this has been a favorite of many pundits, for the sole reason that I believe the gold prices have run up to the level where the demand for the commodity will suffer. Gold is NOT one of the essential commodities. I feel that natural resources (mining, timber, agriculture, etc) will be a good hedge against inflation and countries that are rich in natural resources will have stronger economies and will have strengthening currencies against US Dollar. Therefore I would say one would be wise to consider a part of their portfolio to be linked to countries rich in natural resources such as Brazil, Canada and Australia. If you want to play the currencies, you can use the forex markets or even buy cds linked to foreign currencies (I think Everbank offers this facility), but do this purely to hedge. Growth should always come from investing in a business. Even buying real estate in US may be a good move, although I would imagine not everyone will be comfortable doing this for investment purposes in this environment.
US no longer the growth engine of the world
Well, it has not been the growth engine of the world for many years in the past but the size of the US economy has ensured that when US sneezes, the world catches cold. The future is likely to be very different from the past with the relative importance of the US economy diluted even more. There are many reasons why I think this will happen and some of the reasons why I think the US Economic Future is Uncertain are outlined in this article I posted a while back. Needless to say, I recommend that investors increase their exposure to non-US assets or at least start investing in US companies that do a large part of their business overseas. International themes may be hard to play for simple reasons that we may not have time or resources to conduct the research needed. There is also a political risk and currency risk to consider. For this reason, diversification becomes very important when investing abroad and ETFs can be some of the lowest cost option to construct a diversified portfolio.
As always, if you do not yet have a sufficient emergency fund, focus on building that first. Then consider your risk tolerance before you decide to invest in stocks. There are many low risk investments available that will do a better job of preserving the value of your dollars compared to a CD or a savings account. And finally, consider the advice of your professional financial advisor before making any changes to your investing strategy.