How To Survive A Recession

The U.S. economy appears to be on the verge of a recession.  Of course we won’t be able to say for sure for several more months since a recession by definition requires six consecutive months of negative economic growth.  Nevertheless, many of the signs are there.  Retail sales are disappointing, housing prices continue to fall, and lenders are becoming more reluctant to lend money as we appear to be experiencing a global credit crunch.

The recent massive rate cuts and economic stimulus package indicates that the government thinks the economy is in worse shape that many had originally expected.  While these actions may indeed boost the economy and financial markets in the short-term, over the long-run they may lead to an even worse recession in the future.  

One of the primary issues with the current economy is that the average consumer is very highly leveraged.  They have taken out home equity loans and racked up high credit card balances to support a lifestyle they couldn’t afford.  The sub-prime loan crisis was in large part caused by individual’s sense of entitlement to houses they couldn’t afford. 

The motivation behind the Fed’s recent rate cuts is to make money cheaper by enticing consumers and businesses with lower interest rates.  Unfortunately, giving highly-leveraged consumers access to cheaper money may hurt the economy in the long-term as they use cheap debt to continue to fuel a lifestyle they can’t afford. 

Greed and indiscretion has led us to this point.  Government handouts and cheaper debt won’t correct the situation.  And it goes much deeper than just the housing market.  Household spending, consumer debt, financial sector profits - all need a correction to get back to sustainable levels. That's bad news for investors and the global economy, which still depends heavily on U.S. consumption for growth.

So how can you navigate the current market volatility without losing both your money and your mind?  Well, maybe the most important advice is to take a step back and remember that it’s just money.  Money should serve you, rather than you serving money.  That being said, there are some specific investment strategies you can take to benefit from the current market conditions.

Bear Funds

There are several mutual funds out there which hold “bear” portfolios.  These are funds that sell short, buy put options, use leverage, or employ other strategies to increase in value as stocks decrease in value.

Bonds

When the stock market begins to decline, investors often run to the safety of bonds.  This ends up driving their prices up and their yields down.  Also, the recent Fed rate cuts have also hurt bond yields.  A 10-year government bond currently yields around 3.5% while a high-quality corporate bond yields around 5%.  So while bonds tend to be much safer than stocks, don’t expect them to deliver spectacular returns.

Defensive Stocks

Defensive stocks are those companies which tend to perform well regardless of whether the economy is good or not.  These are consumer staples companies – providing products that consumers need regardless of the economic situation.  Food and utility stocks are perfect examples, as consumers will still need to eat and warm their houses regardless of what the overall economy does.

Precious Metals

When the stock markets falls, investors tend to flee to the safety of precious metals.   Already gold prices have topped $900 and most expect it to top $1,000 before the year is over.  It’s possible to capitalize on these rising prices by either investing in individual mining stocks or precious metal funds. 

Value Investing

It’s easy to get depressed when you see the stock market dropping and all you hear is gloomy news about the economy, but maybe you are taking the wrong point of view.  When people go to the mall and find a spectacular sale – they are generally quite excited.  The same can be true in this current market.  Lots of good quality companies suddenly find their values greatly depressed by the current economic misery.  Buying these companies can end up being the smartest investment decision you make.  For example, after the dot-com bubble burst, Corning (GLW) saw its stock price drop to under $2 per share in late 2002.  However, just four years later the stock price was back over $20.  Individuals who were able to invest in a pessimistic marketplace ended up with phenomenal returns.  Those types of returns are only made possible by the excessive negativism that prevails during a bear market.

Finally, it’s important to remember is that even the worst economic recessions don’t last forever.  The U.S. economy is extremely resilient.  Over the last 63 years, there have been 10 recessions. The average length of these downturns has only been about 10 months.  In fact, there have only been 2 recessions in the last 25 years (early 1990’s and 2000-2001) and both have been relatively brief.

So while the economy will certainly recover from its current recessionary woes, the prudent man still should foresee the evil that could come over the next few months or even years.  Unemployment always rises in periods of economic recession.  So now would be a good time to make sure you have an adequate Emergency Fund in case the worse should happen.  It is recommended to have at least enough money set aside to cover 3-6 months worth of living expenses.  This money should be kept in a safe and highly liquid savings or money-market account.

It is also a great time to focus on any outstanding debt that you do have.  Recent Fed rate cuts have lowered mortgage rates to their lowest level in years.  So it may be wise to consider refinancing your home if you have a higher interest rate.  Also, any credit card debt you have should be attacked immediately.  Living a financially-responsible lifestyle will enable you to weather any type of economic conditions.