Investing For The Next Recession
We recently wrote an article entitled "No Recession Now, But When?" which discussed that recessions are part of the normal economic cycle. We stated: "It is an indisputable fact that a recession is coming. For economists, and analysts, the "R" word is as feared and loathed as the plague. A mere mention of the word will send them running in panic, pointing fingers and screaming heresy. The reality, however, is that recessions are part of the normal business cycle where the economy removes the excesses that were built up during the previous expansion."
We discussed this idea in more detail on Fox Business News (video below) recently discussing in particular where the related investment risks are and where investors should be looking investment wise to mitigate a recessionary pull on portfolios. One area in particular where investors need to be paying close attention is in "high yield" funds. Wall Street used the name "high yield" because it markets to investors much better than the negative connotation of what these funds really hold - "junk bonds." In a recent article we discussed the chasing of yield by investors and the excessive risk that is being unwittingly taken on.
One thing to note in that article was that the spread between junk and AAA rated bonds are now reaching levels that have historically been associated with the onset of recession.
As we stated in the article: "The problem for those heading into, or in, retirement is the quest for income and safety. After the last decade the "return OF capital" has become much more important than the "return ON capital." With a sluggish economy affecting wage income, interest rates at historically low levels, and current standard of living costs on the rise - investors have been systematically pushed into chasing yield. The continued artificial supports and interventions by Central Banks, both domestically and globally, have led to a false sense of security that markets will continue to travel upwardly, and "high yield" bonds will continue to pay, indefinitely into the future. That event is as unlikely as subprime loans being "contained."
It is important to understand that I am not saying that a recession or market crash is about to happen. The markets, especially when running on "hope", can remain elevated for far longer than logic would dictate. However, reversals in the economy, and the markets, come very quickly and will blind side investors lulled into a false sense of security."
What is important for investors is an understanding that, despite claims to the contrary, a recession will occur in the future. It is simply a function of time. These recessionary drags inflict lasting damage to investment portfolios over time. The average draw down during recessionary periods is 30.76% with an average recovery period of 43 months. For someone close to, or in retirement, this can be devastating.
While the economy is currently not in a recession the negative trends in the data certainly require monitoring. With very low lead times between non-recession, and recessionary, states it is very easy to get swept up in the mean reversion process as forward expectations are realigned with current earnings and economic growth trends. With a market that is driven more than ever by momentum, low volume and high-frequency trading - these reversion processes will continue to swift, and brutal, leaving investors little time to react to market changes. This time is NOT "different" - a recession will reassert itself at some point. What is important is whether or not you are prepared to deal with it.