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The Coronavirus has had a dramatic impact on every facet of our daily lives. Of course one of the most significant has been the economy. Practically the entire world is suddenly working from home and hundreds of thousands of businesses have been forced to temporarily close or severely limit their normal operations. The stock market has noticed: as of March 31, the Dow recorded its worst first quarter in history (down 23.2%). The S&P 500 recorded its worst quarter since the last three months of 2008 (down 20%), and we all remember the recession that followed.

So are we officially in ‘recession’ territory? Some might argue ‘yes,’ while others are optimistic to see what happens when the Coronavirus eventually subsides. The next few months will be critical.

If you are concerned about the possibility of a coming recession, you may be wondering what you can do to prepare your investments for the bear market. Although a recessing economy is nothing to look forward to, that doesn’t mean that you can’t achieve financial stability and even success during difficult times. Let’s outline some strategies...

How Should You Adjust Your Strategy?

When you are dealing with a bear market, you need to use a different strategy than during a boom. Although there are some impressive stories of speculators making a fortune during recessions, that is not the norm and is not typically something you should pursue. A few smart choices can help you continue to steadily and safely increase your wealth without unnecessary risk.

Do You Need Cash?

A lot of people have a gut reaction to sell their positions and hold onto cash during a recession. However, this may not be the right decision. Your cash levels should be based more on your situation, not on the overall market trends.

What is the likelihood that your income will be harmed by the recession? If you expect to need cash to help with your everyday expenses, you may want to sell off some of your portfolios.

However, you don’t need to liquidate everything just because of the bear market. It will be bullish again. Every bad market in history has turned around eventually.

Also, consider whether you will need the money from your investments in the next five years. If so, you likely want to take a relatively risk-averse investment strategy. However, if you won’t need it that soon, you can tolerate higher risk as most stocks will increase significantly after the recession.

How Should You Adjust Your Portfolio?

Even if you aren’t liquidating, you may want to change some of your positions. Highly leveraged, cyclical, or speculative investments could be very dangerous during a bear market. While the market will eventually turn around, poorly managed and recession-sensitive companies may go under. You don’t want to find yourself betting on the wrong stocks.

Before we discuss what the winners and losers of bear markets are, keep in mind that you should generally avoid investments in businesses that have high debt-to-equity ratios, are overly tied to economic confidence or that may currently be overvalued. These will be the first to fall. Changing your portfolio for some more robust investments while riding out the recession is a good idea. You can then be well-poised to make some riskier investments when things start to rebound if you so choose.

Avoid trying to time the market. While some investors manage to earn serious returns by doing this, it is very high risk. Unless you are very confident in your bets, be careful about making predictions on the end of a recession.

Who Are Typical Bear Market Winners and Losers?

During a recession, you can expect some types of businesses to stay strong and some to sink. Unsurprisingly, the ones that do the best are usually those with strong fundamentals and value that is based on financial performance rather than speculations. These are some of the types of investments you can expect to perform well in a bull market:

  • Strong Balance Sheets: Debt-to-equity is a big indicator of whether a company will do well in a recession. If it has low debt and good cash flow, it can likely stay strong even if the markets are contracting. Consider looking for businesses with a history of paying dividends.
  • Recession Resistance: Some industries have relatively inelastic demand and are very resistant to recession. Companies that provide staples, such as grocery stores, cosmetics companies, alcohol manufacturers, and similar businesses, tend to outperform other industries.
  • Counter-Cyclical Investments: These investments are priced against the prevailing trend of the market. During a bear market, they will increase in value. Utilities, consumer staples, and defense all fit into this category.

While the above types of investments tend to do well in a recession, you will want to avoid the following as they tend to lose the most value:

  • Highly Leveraged Businesses: As mentioned, debt-to-equity is a good predictor of bear market performance. If a business is highly leveraged, it will likely struggle. Loans are harder to come by and revenues normally drop, hurting cash flow.
  • Cyclical Stocks: These are investments that are heavily based on confidence and employment levels. They do very well in bullish markets but struggle during recessions.
  • Speculative Investments: Any investment that is based on optimism will likely struggle. Many overvalued positions will be the first to see corrections when a bear market strikes.

Recessions can be a scary time for many people, but they simply are a fact of life. Along with periods of growth, the economic cycles include periods of decline, which naturally causes the most concern for investors. Determine what your own risk-tolerance is, and incorporate some of these strategies to limit portfolio losses and possibly even realize some gains during a recession.

 

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