While the stock markets might be experiencing a bounce from the COVID shock earlier this year, the consensus among analysts is that the broader economy is heading for a reckoning. Storm clouds are already appearing on the horizon as mortgage defaults and forbearances skyrocket, small businesses buckle under the pressure of the lockdowns, and corporate bankruptcies accelerate.
As a value investor, this means that you will have your work cut out for you. Especially as you will need to continually monitor the market for opportunities to acquire underpriced assets on the cheap. In some ways, this is a plus as the market’s run over the past few years made it more difficult to identify values. But the current environment also means that you need to do your homework before executing a trade.
With that in mind, there is some value investing strategies that work during a recession. As with all investment ideas, you need to keep in mind that they need to be applied in the right circumstances. There is always an element of risk, and for some value investors, especially those who cannot afford the losses, the right strategy might be to sit on the sidelines – at least until things are less volatile.
During recessions, the worst-performing assets tend to be speculative, cyclical, and going through a downturn, or loaded up with debt. For investors who want to survive need to avoid these companies. Instead, they should focus on companies with solid balance sheets, recession-proof cash flow, low debt, and are in industries that traditionally do well when the economy is not healthy.
This means seeking out companies that are well-managed with low debt loads such as counter-cyclical companies. These companies tend to do well when the rest of the economy is underperforming.
Examples in the past included pharmaceutical, educational service, insurance carriers, and public service industries. But you will probably want to dig deeper as trends specific to the current downturn (e.g., the potential for losses at health insurers or uncertainty in higher education) could impact some of these companies this time around.
The theory is that companies in counter-cyclical industries will do well when everything else is going bad. But just keep in mind that every recession is different and, in a downturn, when millions are ordered to stay home, industries such as eCommerce, utilities, and possibly entertainment might be able to win big.
Spot Risk and Steer Clear of Risk
Even the most experienced value investors need to be reminded of this from time-to-time. This is because what is considered a value in one market is not necessarily a value in another market. As such, knowing which assets to stay away from in a recession is as crucial as picking the right sectors and stocks.
Another trap to watch out for is speculative investing. Even the best of us get caught up in the excitement and end up investing we will later regret. One way to spot a risky investment is when the asset valuations, or the entire asset class, seem to be riding a rocket ship. In this scenario, there is a point were the valuations no longer make sense, and most of the people investing are doing it out of FOMO or fear of missing out.
But speculation can also happen with stocks that seem to do not get the attention of the street. In this case, it can be harder to determine if the stock is speculative or excellent value. As such, you need to step back before executing the trade and ask if you are about to enter this position because of the facts of your analysis or a hunch.
While hunches can be right sometimes, they should never be the basis for making an investment decision. Too many things can go wrong, and if you are playing on hunches alone, you might as well go to the local casino. You might have better odds at the casino than in the stock market.
The Customer is Always Right
If you are stumped by what is going on in the market, then stick to this one piece of advice – follow the customers. If we learn anything from past recessions, it is that the companies that survive find a way to keep their customers coming back for more. This does not always mean that these companies are the best. Instead, they have enough customers to provide the cash flow required to keep the lights on.
One last thing to think about is how you can protect your assets. This includes not only your investment portfolio but also your home and other assets of value. Recessions are unpredictable, and even someone making 1 million dollars a year can find themselves in trouble.
As such, take a tough look at your portfolio and ask yourself how much risk you are willing to take. Sometimes winning means not losing, and during a recession, cash preservation and asset protection might be the best course of action.
For some homeowners, this might mean taking the seemingly drastic step of tapping into their home equity. For older Americans, one way to achieve this is through a reverse mortgage as they can preserve their equity while freezing their mortgage payments. Also, many of these loans are non-recourse, and that means that the borrower is protected if the value of the home declines.
If you are not sure if a reverse mortgage is right for you, then you might want to check out this calculator created by ARLO. Using it will give you a good idea of the financial impact of a reverse mortgage, and perform further due diligence to see if it is the right option.