Recessions can come without a moments notice, but when they do show up you need to be prepared on how to invest in a recession.
Did you know: For the first time in history, the US will have completed a decade without a recession or depression?
Depending on the pundits you listen to, you will hear a myriad of reasons why the above statement is or isn’t true.
What matters is the actual event of a recession.
What is a recession?
A recession is a period when the economy flattens out or contracts. That’s a very broad definition and, to be fair, not very indicative of what a recession does to people.
Market participants generally attribute the beginning of a recession when GDP drops for two consecutive quarters.
That’s the market definition – the real meaning that people can relate to is: industrial jobs stagnate and people get laid off, international trade slows, pay raises are reduced or eliminated, hiring freezes, and budgets get reduced.
What else gets diminished?
The stock market. When investors get that first little whiff of fear and the big bad ‘R’ word, things sell-off quickly.
Typically risk-on assets like growth and value stocks get decimated, but not everything. Are there stocks that are safe during a recession?
Booze, Cigarettes and Toilet Paper
It may seem a little dark to think about, but you need to imagine how people (including yourself) behave in a recession.
Then you’ll know how to invest in a recession.
Before my wife and I moved to Michigan, I lived in a blue-collar town in Minnesota for most of my life.
Tons of manufacturing in that town: Wilson Trailer, Alcoa (aluminum fabrication), Kolberg-Pioneer (made rock-crushing machines), Vishay (circuitry), etc.
I remember, vividly, what happened to many family and friends from 2007 to 2010. Seeing friends and family out of work, unemployed, and under threat of losing their home isn’t a recession to them.
And during recessions, there are very few things that increase in consumption – one of them is beer and liquor.
Smoking also increases during economic downturns, so stocks like Philip Morris (PM) can outperform the aggregate market.
We’ve looked at why booze, beer, and cigarettes hold out in recessions, but you might be wondering, ‘why toilet paper?’
Because you’ll always need it. It’s not surprising that consumer sectors outperform during a recession.
Companies like TJ Maxx (TJX) have done well in the past five recessions, with TJX averaging +63.9% in the Consumer Discretionary sector.
Because people are more frugal and look for good deals – precisely the kind of environment where TJ Max excels.
Conagra Brands (CAG) has an average 22.9% performance over the past five recessions. CAG is part of the Consumer Staples sector, and they hold brands like Birds Eye (frozen vegetables), Blue Bonnet (baking), and Chef Boyardee.
Another major player in the Consumer Staples sector is one of the biggest boys on Wallstreet: Walmart (WMT). WMT has an average 47.1% performance over the past five recessions.
Why do these companies stay healthy and even thrive during economic uncertainty?
Because they offer goods that people need, and they offer things people want at bargain prices.
How to Invest in a Recession – Real Example
You might assume that needs are more significant than wants in a recession, but that is not true. One of the silent winners of the past ten years is ULTA Beauty – which made a significant amount of its gains during the last recession.
Take a look at the two charts above. The chart on the left is ULTA – a beast in the beauty sector – and the chart on the right is the S&P 500. Both charts are highlighting the same period (March 2009 – July 2011).
You’ll observe that while they both traded higher, there is a massive difference in the performance of the S&P 500 versus ULTA. The S&P 500 gained +104.05% while ULTA gained a staggering +1,573.97% (coincidentally, ULTA is up over +7,500 since the recession).
Why did ULTA outperform the market?
Because ULTA’s customers use discretionary spending on beauty products.
When a recession is active, and wages are lower or eliminated, the consumer’s discretionary spending becomes a precious commodity to companies.
How to Protect Your Money in a Recession – Diversify, Diversify, Diversify
Just because we’ve ‘skipped’ a recession doesn’t mean it won’t happen.
It will happen.
One of the things that should worry everyone who holds many index funds is how vulnerable they will be on any market sell-off.
Capitalization-weighted indexes are heavily weighted in the top-performers. Those top performers are very expensive relative to the mean of the index.
That means that any eventual downturn is going to be exacerbated by the sell-off that occurs in the overweighted stocks.
When I go to my local butcher (I’m lucky I have one), he has open freezers with various meats: beef, pork, venison, pheasant, duck, and turkey.
He probably doesn’t realize it, but he’s diversifying his inventory. If there was a swine flu that required his suppliers to cull their hogs, he still has other inventory to sell.
If the available deer drop due to chronic wasting disease, he still has other meat available for his customers.
Diversification is, literally, not putting all of your eggs in one basket. If we were to think of my butcher’s meats like they were stocks, then we can see one benefit of diversification is the decrease in risk.
Imagine how his business would be if he only sold pork.
Diversification is a popular term. In a nutshell, diversification brings the following benefits:
- Reduces volatility by broadly investing across multiple instruments.
- Broad exposure increases the frequency and opportunities for higher returns.
- The adverse effects of cyclical periods are mitigated.
- A better ability to risk capital into higher risk/reward instruments without putting the entire portfolio at risk.
Overall portfolio risk is greatly minimized.
Commodities and Diversification
Gold is the historical risk-off asset, and it has been for millennia. When Iran recently launched missiles at US bases in Iraq, gold shot up over the $1,600 value for the first time in almost seven years.
At the same time, the NQ (NASDAQ Futures) collapsed -1.85%. While the vast majority of those spikes have retraced and reversed, the opposing moves show the inherent risks one would have had to invest in only stocks or only gold.
Listen, gold is an odd and awesome commodity. You buy it because, in the event of a zombie apocalypse or an EMP attack, it can be used as a medium of exchange than everyone knows a store of value.
Diversification in metals like gold and silver can be accomplished in two ways: physical or paper. I only buy physical metals – I don’t believe in holding paper metal contracts as a hedge.
Mining stocks, though, that’s a different story. Mining stocks react the same way as the metals they mine do, and the mining stocks have outperformed the physical metals by nearly 50% over the past ten years.
But diversifying in metals, from a practical standpoint, should be done with physical ownership – you can even have physical silver and gold in an IRA.
While we’re on the topic of gold, don’t forget about silver. I have ramped up my silver holding massively since September of 2017.
The Gold and Silver ratio is way out of proportion.
Gold and Silver Ratio
The gold to silver ratio is the hedge and diversification opportunity that absolutely no one is talking about.
The silver/gold ratio is currently at 85.85. It was recently at a historical high of 93. What the ratio tells us is that it takes 85.85 ounces of silver to equal one ounce of gold.
What is the historical average? 15.
It’s massively disproportionate, and none of the physically mined metals over the past 30 years can account for this ratio.
There’s a divergence between physical supply and the paper derivatives, and the eventual correction is going to be massive, with silver catching a probable once in a life-time spike to equilibrium with historical means.
Silver also has significantly more applications for use than gold.
Silver is used in batteries, bearings, solar technology, water purification, and desalinization and medicine. It’s the most reflective metal and a better conductor of heat and electricity.
Like gold, there is a finite amount of it on Earth – but most of the gold ever mined in history is still around – silver has been used up.
There’s probably a reason why well-capitalized funds and nations make silver the most manipulated commodity on the market: if the big boys are manipulating something, it probably means you better get on it before it’s too late.
Recessions are bad, and when they happen, equity markets tend to collapse.
But that doesn’t mean your entire portfolio needs to drop – you can protect it and even grow it during uncertainty now that you know how to invest in a recession.
People will always need food, water, medicine, tools, and transportation. Some services and products are a necessity that certain companies provide and will naturally weather a recession better than other stocks.
Metals like gold and silver offer an additional source of security and wealth in the event of any currency crisis.
After 10+ years of a raging bull market, planning for the next market flash crash and economic recession isn’t only prudent, but profitable.
Like Buffett said: “Be fearful when others are greedy and greedy when others are fearful.” and I would like to think he knows how to invest in a recession!