Preparing Your Portfolio for Recession
A few days ago I wrote that the financial markets are pricing in a substantial likelihood of a recession and a significant 30 percent decline in corporate earnings. If that were to materialize, it would make the current decline in the financial markets look like a small bump in the road.
As I wrote, I don't think we are headed there, and I think the markets and the economy will slowly improve. But that doesn't mean folks shouldn't plan and be prepared. So here are a few more thoughts on that...
Pay Off 401(k) Loans
This can compete with the goal to build your cash cushion, but it is more important. If you've borrowed from your 401(k) and have an unpaid 401(k) loan, consider paying it off. The reason is that if you leave your job, most plans require you to either repay the loan within 30 days of termination or they will treat the loan amount as a taxable distribution. This creates an ambush of taxes and penalties because income taxes and early withdrawal penalties will be assessed on the amount of your unpaid loan. If possible, try to pay off these loans from other sources.
Recession Ready Your Portfolio
History can be a guide in respect to how the stock market performs during recessions.
Since 1945, the stock market posted gains during seven recessions and declined in four of them. The average stock market gain over all 11 recessions was 3.0%.
The average length of a recession since 1945 has been ten months.
The most significant stock market losses are typically experienced before a recession.
But the past is not always a precise indicator of the future. As always, long-term investors should follow a few simple rules, such as re-balancing their portfolios. For example, emerging market stock funds posted the largest declines this year and could now be a both reasonably priced and a smaller portion of your portfolio than intended. When rebalancing, you might increase your position in these back to your target allocation, doing so with the intention to get your portfolio back to its target allocation.
With the Feds recent statement about interest rates, forecasting to to keep zero until mid-2013, there's clearly a case to be made for seeking investments that offer three things: high yields, some growth and downside protection. Here are a few options for investors to consider.
Master Limited Partnerships:The most common are partnerships that own contracts to operate energy infrastructure, such as natural gas and crude oil pipelines, shipping terminals, storage facilities, etc. These master limited partnership pay out the bulk of their profits in quarterly dividends. At current prices, here are two MLPs and their yields: Kinder Morgan Energy Partners (KMP), 6.46%% and Enterprise Products Partners, (EPD) 5.63%. Much of the revenue is guaranteed by long-term contracts, and energy demand is a secular global growth story that should help offset a recessionary US decline.
Telecommunications:Can you think of a more recession-proof industry than the national telecom and wireless companies? Global wireless subscriber-ship continues to grow and smart phones have made these services nearly indispensable. Here are a few stocks and their yields in this sector: ATT (T), 5.99%, and Verizon Communications, (VZ) 5.59%, Vodaphone (VOD) 7.16% and Telefonica (TEF) 10.24%. With dividend yields that exceed 7% and a likelihood that the foreign currencies could appreciate against the greenback, the last two offer additional attraction for US investors.
Energy:prices for oil and gas have swung wildly over the past six months. But world energy usage, particularly oil and gas, is at all time highs despite the slowdown in the global economy. This is caused by the growing consumer base in China and India, and other emerging markets. It's hard to see a disruption in this secular trend. A simple and effective way for investors to get exposure to this sector has been through the iShares Dow Jones Energy exchange traded fund (IYE).
Check back in a few days when I'll write about a few more steps to get your financial life prepared, whether a recession comes or not!
