With the threat of a double-dip recession in the near future, investors should position their portfolios to protect themselves from another downturn. “Now is not the time for heroic bets,” says Rob Arnott, chairman of Research Affiliates. “Now is the time for a cautious, sensible, defensive stance so that you have the resources to pounce on opportunity when markets present us with more attractive pricing.” With that in mind, here are 10 portfolio themes that investors should keep in mind in these uncertain times.
Make a plan. Before you start investing your money, it’s important to make sure you have a plan. If you’ll need the money within a few years, say for a home down-payment, it should be in less volatile investments. Many investors get burned by being greedy. “Don’t get sloppy, because a big part of these bear markets is they really expose flaws in your financial plans,” says Russel Kinnel, Morningstar’s director of mutual fund research.
Treasuries. Treasury notes, which are backed by the full faith and credit of the U.S. government, are a reliable source of income even in the midst of a souring economy. Experts suggest that investors keep some portion of their portfolios in treasuries. Still, now is not the ideal time to buy treasuries. For starters, investors have begun crowding the treasuries market, driving the yield on 10-year notes below 3 percent for the first time since 2008. “I’m afraid that by suggesting that people need more, there can be some momentum-chasing,” says Jeff Tjornehoj, Lipper’s research manager for the United States and Canada. Meanwhile, if the economy recovers enough, rising interest rates could plague treasuries.
Dollar-cost averaging. Timing markets is a dangerous game. That’s why many advisers suggest that investors practice dollar-cost averaging, which means investing the same amount of money on a regular basis regardless of what the market is doing. This way you don’t risk putting all of your money into the market when it’s at or near its peak. “You may not get the maximum returns, but if it keeps you from panic-selling, then you’re still better off than you would have been,” says Adam Bold, founder of the Mutual Fund Store.
Gold. In times of uncertainty, many investors turn to gold. The precious metal is a good alternative in the sense that it’s generally not correlated to basic economic activity, says John Derrick, director of research for U.S. Global Investors. “It’s an insurance policy against bad government policies,” he says. He argues that gold should be able to maintain its value better than paper currencies in a deflationary environment.
Defensive stocks. Certain industries have a reputation for performing comparatively well during tough times. Healthcare stocks, for instance, are widely considered to be defensive investments. In 2008, funds in Morningstar’s health category lost an average of 23.4 percent. By comparison, the S&P 500 fell 38.5 percent that year. Still, each downturn is different, and an industry’s relative outperformance during past rough patches doesn’t guarantee it will continue that trend in future ones. Another defensive strategy is to put money in companies with solid balance sheets and strong brand-name recognition, says Kinnel. These picks often do a relatively good job of absorbing the effects of a poor macroeconomic outlook.
Recession stocks. The economic devastation of 2008 debunked the myth that there is a wide array of “recession-proof” industries. But that doesn’t mean that there aren’t individual companies that tend to get a boost when consumers are struggling. In particular, stores that sell staple products at sharp discounts will often benefit from consumers who are suddenly hunting for bargains. Wal-Mart, for instance, was up 20 percent in 2008 as consumers took advantage of its low prices. Similarly, Ross Stores, a discount clothing chain, gained 17.8 percent that year. These companies, of course, are the exception rather than the rule. In 2008, for example, the average consumer staples mutual fund was down 25.6 percent.
Cash. Money market flows have been seesawing as investors try to determine how much of their portfolios they should stash away in cash. A double-dip recession would be accompanied by a plunge in the stock market, so opportunistic investors may want to keep some cash on hand to capitalize on beaten-down prices. At the same time, holding cash insulates investors from losses. “Nobody likes zero-percent returns on cash, but it’s better than the significant losses that we can see if a crisis environment reemerges,” says Doug Noland, a comanager of the Federated Prudent Bear mutual fund.
Don’t miss the rebound. Still, putting too much money in cash can have unintended consequences. Namely, investors often take money out of the stock market when prices are tumbling and neglect to put it back in before stocks start to rally. For instance, over the 52-week period immediately after the stock market bottomed on March 9, 2009, the S&P 500 gained roughly 70 percent. But during that same time period, mutual fund investors yanked more money out of domestic stock funds–$8 billion more–than they put in. Patient investing, in other words, will often yield the best results.
Hedging. A number of different strategies allow investors to hedge risk during uncertain times. For example, long-short mutual funds, as their name implies, have both long and short positions in the market. When the long positions suffer, which typically happens during a downturn, the shorts pick up the slack and put a damper on volatility. “You don’t want to go whole-hog on them, but I do think there are some good ones out there,” Kinnel says of long-short funds. Meanwhile, bear market funds allow investors to get much heavier exposure to shorting techniques. These funds are designed to generate positive returns when the stock market goes down, and vice-versa.
Emerging markets. Compared with the developed world, emerging markets have less debt on their books and much higher growth prospects. Arnott estimates that the United States is running a deficit of more than 140 percent of GDP (after factoring in state and local government debt), while most emerging markets deficits average about 20 to 30 percent of GDP. Currently, emerging markets debt that is denominated in U.S. dollars generally has a higher yield than emerging markets debt that’s denominated in local currency. “That means investors are expecting the dollar to fall relative to emerging markets currencies and emerging markets currencies are likely to rally relative to the dollar,” he says.