Expecting a Recession Next Year? Here are 3 Moves to Consider

Bad news keeps appearing. Japan, the world second largest economy, recently announced its first recession since 2001. Meanwhile, banking giant Citigroup announced its plan to slash about 50,000 jobs, dramatically cutting cost and reducing assets while unemployment in Britain is expected to hit 9% in 2010 (equivalent to almost 3 million people without jobs).

Despite large capital injections into banking systems, government guarantees on bank deposits and co-ordinate interest rate cuts by six of central banks,  a period of de-leveraging (money moving out the economy) appears inevitable and the global economic turmoil shows no signs of abating. The UK, the US and Europe are all ready reporting declining economic growth.  Keith Wade, chief economist of Schroder Investment Management Limited expects growth in the US and the UK to fall by 1.5% and 2%, respectively, while Europe’s growth drops by 0.5% next year.

Unfortunately, these matured economies are perceived to be ‘safe havens. Many foreign investors have redeemed their investments in emerging markets such as Malaysia, only to move their capital back to the economies with declining growth.  As a result, every country is facing a slowdown even those with large domestic driven economies such as Indonesia and China.

Downgrades to next year’s forecasts have been prolific and outlooks are downright bearish. George Soros, the chairman of Soros Fund Management expects the US to go through ‘a deep recession’ and perhaps even a depression, next year.  Soros has a reputation of being a financial soothsayer.  Back in 1992, Soros made over US$1 billion by shorting the UK sterling when he correctly concluded that the Bank of England will not let the currency fall.

Interestingly, Soros has gone on to increase his investments despite his view. The billionaire bought stakes in two Australian mine companies and increased in holding in Brazilian state-run oil company Petroleo Brasileiro in the past two months. Moving into the market now is around the same time as Warren Buffet’s recent shopping spree. Buffet, perhaps the most famous investor in the world, said that he is switching his own money from government bonds to US equities.  His holding company, Berkshire Hathaway Inc also increased its exposure to oil producer, Conoco Phillips, and manufacturer, Eaton Corp, this quarter.

If the bad news proliferates and economies do enter a severe and long recession, what are the options opened to investors?

1. Hold Cash

The saying is ‘cash is king’ when a recession hits and the economy slows down. The money is available for emergencies such as job lost or to buy investments at bargain prices. Note that holding cash is a default position. An investor should not be completely inactive.  As you hold cash, actively pursue bargain funds or bonds. If these opportunities are either priced to give an adequate rate of return to a margin of safety over the risk free rate of return over cash (for bonds), then start making your investment.

2. Position Your Portfolio To Rise When Economies Fall

Marketwatch.com by the Wall Street Journal recently ran a story on three investment advisors that built their careers since the 1970s by doubting the soundness of US’s financial system.  But they didn’t model their portfolios as per their claims and have made year-to-date losses ending October 31, ranging from -64.9% to -70%.  Why didn’t these investors advisors do as they preached and position their portfolio before markets fell?

The conclusion from Marketwatch, is that it is extremely ‘tricky to construct a portfolio that will profit from an anticipated collapse’ and still make money while waiting for the bottom. These three advisors would have lost more had they position their portfolio to rise only when markets fall when they started expecting a bear market.  It can take months or years before the actual bottom is hit. Remember John Maynard Keynes’s famous saying that “markets can remain irrational longer than you can remain solvent”.

Many fund managers and investors are investing in companies that are felt to be better positioned during volatile times. For example, Prudential Fund Management Bhd prefers larger companies with strong balance sheets, significant cash holdings as well as companies that appear capable of maintaining a stable dividend policy. The fund company is looking at companies that serve domestic demand in countries like China and Indonesia.

3. Start Buying

According to Prudential, Asia is now trading at a low level with price-to-book ratio of 1.1x, which was last seen during the financial crisis of 1992 and 1988. Asia’s dividend yields stand at 4.8%. If you believe the long-term outlook for Asia is strong, can stomach further volatility then why not do as Soros and Buffet have been doing? Clearly valuations are cheap and there are buying opportunities. To guide you, the iFAST Research Team have rated markets and written several articles explaining their ‘very attractive’ ratings. Refer to Why 4 Stars Rating on Thailand? and China: At its Most Attractive Level in the Past Decade!

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