Though many experts have been calling for a recession for a while now, they have all been dead wrong up until this point.
It’s important not to try and time the market, but to instead have a well-crafted portfolio that can weather the storms that may (or may not) come our way.
In this video, we provide some background on what has caused the sell-off, how you can spot a recession coming, and provide a few practical tips that we’re using to prepare our portfolios:
What Causes a Recession?
Recessions are a natural part of an economic cycle. Much like a beach has relatively predictable high-tides and low-tides, the financial markets have periods of growth and periods of decline; the trick is learning to expect them.
While governments, companies, investors, and consumers would all love for the economy to continue on an upward trajectory forever, this simply isn’t possible. Over times of prosperity, financial markets and the investors propelling them become extremely optimistic, leading valuations for companies to inflate and become “overvalued” – while there are myriad definitions for an overvalued company, the essence of the definition is that the company does not have strong enough financial fundamentals to earn their valuation.
In the Dot Com Era of 1999, internet companies were the source of such excitement that businesses with little or no proven track record were securing investments; at this time, all it took was a good story to become an attractive investment. Market manipulation becomes a large issue when a system reaches this point: those with no intention of creating real value with a business can fictitiously tell a story, luring investors to put their money into a facade. The perpetrators then take the money and allow the business to fall apart.
This consolidation of wealth leaves few outside of the ‘inner circle’ with less spending power, weaker financial positions, and decreased confidence in the market. When enough investors reach this stage, investments slow down, and companies that are overvalued come back down to their ‘true levels’, causing further investors to lose money. This cascading loss exacerbates the issue and causes instability in the economy, forcing the government to intervene. The issue is…
“Every government intervention [in the market] creates unintended consequences, which leads to calls for further government interventions.”
– Economist Ludwig von Mises
How Can I Avoid Losing Money?
When it comes to recessions, this is quite literally the million-dollar question. Unfortunately, there is no straightforward answer.
The best way to defend against recessionary losses is to ensure that you have a well-diversified portfolio that is able to survive a weakened market. Additionally, you should be prepared to extend your investment horizon on many of your positions, as it is likely that it will take some time for your investments to fully recover.
Perhaps most importantly, do not be afraid to take chances on a downtrodden market. Warren Buffet recommends to “be greedy when others are fearful” and, in a recession, most investors are fearful due to the recency bias. This bias leads investors to believe that whatever has happened most recently (ie the onset of a recession) is the most likely outcome of the near future, thus dissuading them from investing in the market.
By keeping cash-on-hand and purchasing undervalued stocks in a recession, you are setting yourself up to capitalize extremely well on the natural market recovery.
These are just a few of the tips to make money in a recession; for a more detailed explanation of what to do, watch the full video above!