Is a recession coming? Warren Buffett thinks so.
In his latest letter to investors, he outlines exactly why the economy will sink into recession. It all started with COVID and government stimulus to combat the economic effects of the pandemic. The government flooded the system with stimulus money. It didn’t help that the Fed added fuel to the fire with 0% interest rates. Everyone who owned a home refinanced their mortgage, dropping their mortgage payment substantially. This freed up cash which was stimulative in its own right. And, of course, the government handed out a ton of cash to individuals and businesses.
With all the extra cash, consumers bought “stuff.” Lots and lots of stuff, which depleted the inventory on hand at many retailers.
In response, retailers bought as much inventory as they could get their hands on. By the time that inventory arrived, consumers began to slow their purchases because of rising interest rates. The stimulus wore off; unfortunately, retailers were stuck with all this inventory. This will hit the company’s bottom lines and stock prices.
A recession is imminent. Of that, there is no doubt. How severe the recession will be, nobody knows. But there’s no point in speculating the severity of a recession when it comes. It’s important to prepare now to avoid getting caught off guard. So, on that subject, how prepared are you for a recession? More specifically, how ready is your portfolio for a recession?
Building a resilient portfolio – one able to withstand a recession – helps to work backward. Let’s first ask what assets are most vulnerable to recession. Which assets do not do well in a recession? Clues to that question can be found in the last Great Recession and the COVID-induced mini-recession in the Spring of 2020.
In an uncertain or recessionary climate, stocks take a hit because investors begin panic selling to liquidate their assets for cash to brace for impending financial pain, including unemployment. In a market crash, the contagion is widespread – with no industries spared from crashing stock prices.
When investors are panic selling to liquidate their assets, they’re not thinking about which stocks they should hold onto and what industries will be less affected than others. They’re thinking about putting food on their tables, and they will liquidate without discretion. Even the rich who don’t need to liquidate their stocks for cash end up liquidating anyway because everyone else is doing it, so why should they wait for prices to hit rock bottom?
In 2008, those heavily allocated to stocks saw their portfolios shrink 50% in the aftermath of the subprime mortgage crisis and ensuing real estate and stock market crash. In March 2020, in the early days of COVID, the lockdown-fueled recession dropped stock prices by over a third.
Stocks don’t fare well during a recession, and strategies built around stocks, like the 60/40 portfolio (60% stocks/40% bonds), also don’t fare well. Allocate away from stocks if you want to survive a recession. So, what should you allocate to?
The people who are most prepared for a hurricane or other natural disaster all have something in common: they are currently assessing their state of preparedness.
Do they have the necessary supplies? Do they have an escape route if forced to evacuate?
Preparedness always begins with an assessment and an inventory. To prepare for a financial disaster, the first step is to assess your current state of preparedness. Take inventory. Review your portfolio. Are your assets vulnerable to recession? Are you highly allocated to traditional assets that are susceptible to downturns?
If you determine that your portfolio is vulnerable, the worst thing you can do is nothing. In a time of impending financial crisis, maybe it’s time to consider a different allocation – one involving assets that are historically resilient to recession and stock market crashes.
What do these assets look like? The investing habits of the ultra-wealthy offer a clue. The guiding principles of sophisticated investors are built to prosper in any economy and built to withstand recessions.
The guiding principle of wealthy sophisticated investors is to allocate to assets that generate passive income to compensate for potential loss of income and that are uncorrelated to the broader markets.
This guiding principle can be boiled down to these subparts:
- Invest for demand.
- Invest in private markets.
- Invest for passive cash flow.
- Avoid market volatility.
Are you prepared for a recession? How are you allocated? Are your assets vulnerable to a downturn?
If you’d like to learn more about the types of assets ideal for combating economic uncertainty, contact my team about the availability of recession-proof investments.