Recession Protection: How to Profit in an Environment of Losses
Updated: Dec 17, 2019
While we might find ourselves enjoying several more months of positive growth in the financial markets, the economic community is strongly considering the possibility of an upcoming recession in 2020. In this case, investors are aiming to alter their portfolios and begin investing in a different strategy in times of economic suffering.
Without further ado, consider the following optimal ways to overcome a recessionary drawback and profit while the markets plummet.
1. Turn towards consumer staple-goods companies
Toothpaste. Shaving Cream. Milk. Bread. Whether we’re in the fastest growing economy in the world or a state of financial doom, these are essential goods in every household i.e. they hold highly inelastic demand. This means that the demand for these products are seldom affected by a change in price, and therefore suggests that the companies backing these goods are unlikely to face severe downfalls.
For example, consider the performance of Colgate-Palmolive compared with Louis Vuitton Moet Hennessey during the financial crisis of 2008.
Figure 1: Colgate-Palmolive Performance during 2008-09 Recession
Source: (The Motley Fool, 2019)
Figure 2: LVMH Stock Performance during 2008-09 Recession
Source: (The Motley Fool, 2019)
As depicted above, the responsiveness of LVMH stock to the financial crisis is far greater than the minimal drop in Colgate-Palmolive. LVMH – a luxury goods manufacturer – would’ve certainly suffered from the diminishing income because this means a reduction in disposable income worldwide. As a result, less people would be inclined to spend their money on luxury goods and services, which caused the company to lose HALF its market value in the space of several months ($100 per share to $50).
On the other hand, Colgate-Palmolive provide products that are reasonably priced yet constitute the everyday needs of the rational consumer, in which case their drop was only half as much as the former: i.e. they suffered just a 25% drop ($40 to $30).
This elucidates the fact that consumer essentials are likely to always retain their demand, in which case the companies that produce these essentials are unlikely to see massively declining revenue. Therefore, this makes the latter group a more reliable form of investment during times of economic uncertainty.
2. Cash, Cash and more Cash
Ironically, in times of recession, building cash reserves is perhaps the most effective thing to do: when everything goes on discount, how would you buy them without cash?
While one’s capital could partially be placed into reliable investments such as the ones described in Point 1, it would be effective to leave the rest of the capital as cash.
Warren Buffet warned investors to pursue this motive on national television back in 2008, clearly exclaiming that now (economic downfall) is the best time to buy…but most retain investors believed that the stock market was doomed for the foreseeable future and didn’t feel like risking any more of their money. A sensible decision, but a costly one nonetheless. Here's why:
Within several months of the crisis’s ending, the stock market soared to record highs, creating hundreds of millions of dollars for those who bought shares during the period. Warren Buffet made over $11 billion within a few weeks of the market correcting: all because he understood that he needed to keep cash aside to buy the stocks when they all fall. This is seen below between his ages of 72 and 83: a range which includes the 2008 crisis as well as several years after.
Figure 3: Growth of Buffet's Net Worth:
(Source: MP3EW, 2019)
Moreover, Tony Robbins found – after interviewing 50 of the greatest financial minds in our society – that every singly stock market crash has been followed by an incredibly powerful bull market (i.e. stocks soar upwards of 50%), which means that purchasing stocks during the down period is perhaps the most rewarding set of investments that you can make, because the growth afterwards will generally be incomparable.
Thus, experts are exclaiming that all potential investors should keep cash aside, in order to feast on the remains of the next recession.
3. Seek Abroad
When the peril in one market is indefinite, it’s wise to retain one’s reliable positions but additionally pursue further opportunities globally. Chances are that the financial situation in other countries may be better, and even allow you to grow your income simultaneously whilst there’s a recessionary period in your own country.
For example, economic growth in Japan has been reducing at significant levels, with growth augmenting at lower-than-expected rates for over 5 years till date. While Japanese investors may achieve some returns from domestic investments, investing globally may bring up additional revenue streams for potential profiteers. Consider the specific scenario below:
Tony is a Japanese investor with $1000 currently trading in the Nikkei index (S&P500 equivalent in Japan). Due to slightly meager economic outlook, the Japanese economy is failing to produce adequate returns.
Given the fact that Tony understands the Japanese market and favors the outcome of his current positions, he keeps his $1000 in the Nikkei Index, but simultaneously uses his $500 in cash reserves to pursue opportunities in India and the US, whereby the stock market has performed favorably since 2019 began.
Thus, even though financial performances are meager in Tony’s main economy, he pursues more opportunities globally, whereby profits can be far higher in the short term.
Leveraging the inelasticity of certain companies such as toothpaste, toiletries, and dairy manufacturers will allow investors to hold more reliable options during times of economic uncertainty. While the reward may be less, the risk endured is also far lower than usual, which is why this is the optimal choice for defensive investors.
Staying in cash could be one of the most effective investment decisions in recessionary periods due to the ability of purchasing stocks when they’re on discount: something that creates substantial wealth, as evidenced by the aftermath of 2008 crisis. Failing to keep reserve cash aside causes investors to lose out on the opportunity to make over 100% returns, which is why this is perhaps the most critical point to address.
With the cash kept aside, investors can buy stocks on discount but also pursue opportunities elsewhere. Global markets are emerging more prominently each year, which suggests that there is a myriad of profitable endeavors that can be discovered in different economies when local ones are relatively stagnant.