job growth provides further support for focusing more on capital
preservation than capital accumulation.
next recession may be the subject of talk around the watercooler and at
cocktail parties, you don’t have to know when the next recession will
occur. What you do need to know is that economic
growth is already weakening.
Why? Because slowing economic
growth will place downward pressure on corporate profits, a key ingredient in
stock valuations. It can also create a
negative feedback loop in which slowing economic growth leads companies to
pullback on investing (which they already have) and eventually hiring leading
to further slowing of economic growth and the cycle continues downward.
point, stock market investors will no longer be able to ignore slowing economic
growth and corporate profits. When
that happens, stock prices will fall and unlike periods over the
last couple years when stock prices fell and rebounded, at some point they
won’t immediately rebound.
This will not only negatively impact stock portfolios; it will
negatively impact consumer confidence and spending. A pullback in consumer spending, if severe
enough will lead to a recession.
Why? Because consumer spending is
the primary driver of economic growth today as business investment and trade
are detracting from economic growth.
INVESTMENT STRATEGY APPLICATION
indicate the following as a prudent investment strategy:
Maintain a diversified portfolio
with a clear defensive positioning
Maintain a portfolio that will do
better in a slowing economic environment. Said another way, maintain a portfolio that is
less vulnerable to the negative impacts a slowing economy will have on the
stock market and the ability of less financially strong companies’ ability to
make their monthly interest payments.
- Reduce your allocation to
stocks below your long-term target allocation
For example, if your long-term allocation
is 50% stocks, reduce to something less.
How much less depends on the following:
- How willing are you to possibly lose 10% to 20%
in your stock portfolio AND have it remain down for a few years?
- Looking at it from the opposite perspective, how
willing are you to miss out on the opportunity to buy stocks at 10% to 20% less
than they are today?
- When do you need to cash out your stocks? The sooner you need to cash out your stocks
the more you want to lower your allocation to stocks.
- For your stock allocation, focus on:
- Stocks that are less dependent on economic
growth or said another way, less impacted by slowing economic growth
These are often called Consumer
Staples. They make the goods people use
every day. Recession or not, people will
need to eat, drink bathe, and brush their teeth.
Companies that make or serve food
are generally less dependent on economic growth. During a recession you may cut back on eating
ut, but you will still need to get your food somewhere. Maybe it means buying prepared foods instead
or cutting back on prepared foods, but you will still need to eat.
Companies that make personal care
products such as toothpaste, dental floss, shampoo, and deodorant are also less
dependent on economic growth.
- Stocks with higher dividend
Today’s slowing economic growth
and low yield environment make stocks with higher dividend yields
attractive. Higher dividend yielding
stocks are generally less susceptible to the negative effects of slowing
economic growth and, if you are going to be exposed to the volatility of the
stock market, at least get a higher dividend yield.
Consumer Staples, because of their
lower growth prospects, often have higher dividend yields and as result they not only offer lower sensitivity
to slowing economic, they offer higher dividend yields.
Utilities also offer higher dividend
When economic times get tough, slumping sales can lead to companies
having challenges in paying their bills and making payments on their debt.
Companies with greater cash on hand and access to financing, will
generally better weather economic downturns.
In a slowing economy, a strong balance sheet having adequate
cash reserves and lower debt can provide a bulwark against slowing
economic growth. These companies are
sometimes referred to as “blue chip” stocks or “large cap” stocks. They are generally larger companies,
typically found in the Dow Jones Industrial index or S & P 500 index. Smaller stocks that would likely be more
challenged during an economic downturn and reduced sales would be companies
found in the Russell 2000.
Note: Not all large
companies have strong balance sheets. Some are heavily indebted. If you are going
to choose individual stocks as opposed to an index or basket of stocks.
evaluate each company’s balance sheet and importantly, access to financing.
- For your fixed income allocation:
- Fortress balance sheets
Similar to when evaluating stocks, seek out bonds from companies with
strong balance sheets. This means
companies that can safely meet their debt service obligations, have ample cash
to supplement interim periods of slumps in cash flow, and access to additional
financing to provide additional short-term financing to supplement lower cash
flows when cash reserves are inadequate.
These companies typically have investment grade bond ratings.
Note: There can be meaningful variation in company balance sheets even
among investment grade companies. A
meaningful economic slump and slowdown in sales would push some lower quality
investment grade companies into non-investment grade status. The lowest investment grade rating for S
& P and Fitch is BBB- and Baa3 for Moody’s.
investing in fixed income, you don’t get paid more when company cash flow
increases. So, focus more on the
companies having fortress cash flows.
These are companies that have steady, reliable income streams. These can be less economically dependent
companies like Consumer Staples. They
can also be utilities. They can also be
companies with a subscription service. It
can also be companies with what they call high switching costs. Switching costs are the costs associated with
switching from one product to another.
For example, switching from a Mac operating system to a PC operating
system is expensive from the time involved alone.