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The 3 ways to win during a recession

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This is the “Profit” part of Benefit and Protection.

Today we are going to take a closer look and consider the “Protection” part of the newsletter. When markets are in free fall, investors must also learn defensive strategies without fear of missing a rebound.

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The 3 ways to win during a recession

The 3 ways to win during a recession

Consider a well-known stock chart.

The 3 ways to win during a recession

The draw of 2022 barely fits on the chart of this magic firm. In fact, the Covid-19 pandemic and the tech crash of 2000 both look like minor bumps along the way.

The company, of course, is that of Warren Buffett Berkshire Hathaway (NYSE:BRK-A), a conglomerate of high-performing industrial and financial firms rolled into one neat Omaha-based package (with a few Sees’ Candies to boot). It’s a company that has weathered war, inflation and recessions to become one of the stock market’s all-time top performers.

Yet even Berkshire has holidays. In 2008, BRK’s share price fell 32% during the financial crisis. And in 2001, Mr Buffett’s business lost 6% of its net worth after the September 11 attacks triggered massive insurance payouts. Removing those down years would have tripled the return for Berkshire investors.

Investors today face an equally depressing prospect of potential losses. Interest rates have barely risen to 1% and equity markets are already experiencing a prolonged bear market. Even Berkshire Hathaway fell 10% in less than a month.

So how should we invest in a recession?

Option 1: Diversify into US equities

What if I told you that you could earn 9.62% guaranteed income? Backed by the full might of the US federal government, no less.

Impossible, you say.

But that’s what Series I bonds pay now. Abnormally high inflation in April made these inflation-linked bonds some of the best performing assets in the market.

The growth of these bonds reflects the importance of diversification. By spreading savings across multiple asset classes, investors give themselves room to absorb market shocks and double down on cheap bets during rallies.

Consider international stocks. Today the Schwab Core International Equity Fund (NASDAQ:SICNX) trades at barely 11 times the price-to-earnings ratio – half of US-based companies S&P500 — while maintaining a comparable return on equity. Some U.S. real estate markets are still offering high single-digit cap rates thanks to soaring rental prices.

The US stock market represents only one tenth of the world’s wealth. Remember that when deciding how to allocate your assets.

Option 2: Use quantitative investing to increase returns

Meanwhile, investors still have plenty of recession-proof options in the market. According to research by Fidelity, consumer staples and utilities have beaten industrials and technology by 20% or more during recessionary cycles.

The 3 ways to win during a recession

Similar studies also show that momentum strategies work during drawdowns.

The 3 ways to win during a recession

In these cases, it is not the most dynamic companies that succeed during recessions. Surprisingly, they aren’t the “buy the dip” laggards either.

Instead, it’s the intermediate actions who do best. These companies, which posted an average return of -2% in Q4 2007, would come out of H2 2008 largely unscathed from the stock market meltdown.

This has immense implications for today’s market. Rather than buying booming energy stocks or plummeting tech stocks, Today, traders should focus on mundane companies in the commodities, utilities, and telecommunications sectors.

Consider AT&T (NYSE:J), a telecommunications company with currently one of the highest dividend yields of any large-cap company.

Since February, stocks have remained in a 10% trading band, a good sign of an average company. AT&T is also in the telecommunications sector, an area that has historically outperformed during recessions.

And the best part? AT&T has a hidden catalyst:


In 2020, rival T-Mobile (NASDAQ:TMUS) completed its merger with Sprint, reducing the number of telecommunications providers in the United States from four to three. Investors should rejoice (although consumers will eventually face higher prices).

It’s a story long-term investors have seen. Airlines… ammunition… tobacco… Whenever an industry with high regulatory barriers turns into a three-way oligopoly, markets quickly become “irregular,” as one study puts it.

Today, mobile phone users are beginning to see the impact of the Sprint/T-Mobile merger. T-Mobile’s cheapest phone line now costs $60 a month, reversing years of falling prices. Even AT&T – a company criticized for its mismanagement of WarnerMedia – now expects operating profits to grow 5% per year from 2023.

These are the types of investments that power quantity-based strategies. AT&T is flying under Wall Street’s radar with a cheap valuation of 6.7x P/E and 12x EV/EBIT — about 30% below its long-term average and less than half the price of T-Mobile. And if quantitative investing is any guide, companies like “Ma Bell” will outperform as America enters its recessionary cycle.

Option 3: Outrun recessions with big winners

Finally, investors can still swing for the closes with big bets. In the first half of 2008, netflix (NASDAQ:NFLX) posted a gain of 67% while First Solar (NASDAQ:FSLR) increased further. These high-growth companies can often help investors weather bear markets.

Many battered tech stocks today look like Netflix in 2008. Metal desk (NYSE:DM), a company featured in The Moonshot Investor, is now trading within spitting distance of its estimated $1.50 acquisition value. And companies like XL fleet (NYSE:XL) have become so cheap that their market capitalization is less than the cash on hand.

Not all Moonshot bets will survive an impending recession. Poorly capitalized companies will find it more difficult to raise funds and the weakest players will fold. And competition tends to eliminate crowded markets; it’s hard to see how the 26 EV makers will survive.

Yet many promising companies have become cheap one-sided bets on a brighter future. Those willing to kiss a few frogs and lose money in the short term will be rewarded when markets finally return to growth.

Bottom Line: Today’s Bulletin Adds AT&T to the “Profit & Protection” Buy List for Low Price and Revaluation Catalysts.

The Schwab International Core Equity Fund, Desktop Metal and XL Fleet offer attractive alternatives.

Choosing the bottom of the market

“That’s it, I’m done,” an exasperated friend told me over the weekend. “Markets are too depressed to continue.”

In a sense, he is right. We are barely at the end of the economic cycle and people are dealing with losses unprecedented since the financial crisis of 2008.

Everywhere, bubbles suddenly burst.

Those trying to “buy the dip” were also disappointed. Stocks of high growth companies Sea Ltd (NYSE:SE) for Cloudy (NYSE:REPORT) fell by more than half. Rising rates and high valuations mean stocks have yet to fall.

The 3 ways to win during a recession

Yet seasoned investors have all been here before. And those preparing for the next recession will have dry powder to invest when valuations finally hit bottom.

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As of the date of publication, Tom Yeung had (neither directly nor indirectly) any position in the securities mentioned in this article.

Tom Yeung, CFA, is a Registered Investment Advisor on a mission to simplify the world of investing.


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