Are you worried about a potential market crash in the next two years?
You aren’t alone.
This year, the financial media has been rife with speculation about an upcoming bear market. Between trade instability and struggling North American manufacturing, many signs are pointing to a coming slowdown. And with a slowdown comes the potential for a bearish stock market.
In a survey by the National Association of Business Economics, 70% of economists polled said they expected a recession by the end of 2021. Economic forecasts aren’t infallible, but that’s a pretty broad consensus that shouldn’t be taken lightly. If such a recession comes to pass, stocks will likely tank, driven by lower earnings and mass pessimistic psychology.
But fear not. As you’re about to see, there are many categories of assets that perform well in bear markets. Some of these are low risk debt securities that you probably wouldn’t want to hold forever, but others are equities that can outperform in both bull and bear markets.
Each of these investments has a particular strategy associated with it, which, when taken together, can form the basis for a recession-proof portfolio.
Move into short-term bonds
The safest thing you can do in a bear market is hold short-term bonds. Short-term bonds are less volatile than long-term bonds, and government bonds are generally less risky than stocks.
Securities like T-bills and GICs carry essentially no risk, while short-term interest bearing bonds carry very little. Of course, by going the “no risk” route, you’ll sacrifice a lot of potential returns–which is where part two of the strategy comes in.
Buy utility stocks
The second part of your ‘recession proof’ portfolio strategy is utility stocks. These are riskier than bonds, but the safest types of stocks in recessions.
Utility stocks tend to fare well during recessions because their revenue streams and dividends are extraordinarily safe. Utilities sell heat and light, one of the most basic life necessities that people can’t eliminate even in the worst of times. Accordingly, their earnings don’t decline as much in recessions compared to other types of stocks.
Consider Fortis Inc (TSX:FTS)(NYSE:FTS). At the end of 2008, it grew its earnings by 26% for the full year; by the end of 2009, earnings had grown by 17% compared to 2008. These were the two worst years of the great recession! It’s a testimony to utilities’ safety during economic downturns.
Granted, Fortis, like most stocks, fell during the recession. But since the company’s earnings were growing, its dividend was never in jeopardy. In fact, investors saw two consecutive dividend increases in 2008 and 2009.
So if you’d bought FTS in 2008, you could have picked up shares at a discount price, watched them grow later, and seen your dividend increase along the way.
Talk about a win-win situation.
Have cash ready to buy shares
Another general strategy for market downturns is to build up a cash horde to buy stocks after they’ve fallen. Here again, dividend stocks like Fortis can come in handy. Dividends gradually build up a cash balance in your account over time, which you can use to buy more stocks.
Using the cash flow from Fortis shares, you could increase your position in FTS by reinvesting, or let the dividends flow out and buy other stocks at discount prices. After a few months of falling stock prices, you’ll likely find yourself at or near a bottom, so you can use your cash to buy up shares you’d always wanted to buy on the cheap.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Andrew Button has no position in any of the stocks mentioned.