How to Invest Before a Recession and Protect Your Portfolio

Mohit Oberoi, CFA - Author
By

Apr. 21 2022, Published 9:00 a.m. ET

The U.S. economy staged a V-shaped recovery in 2021 after the slump in 2020. The economy was expected to slow down in 2022 but Russia invading Ukraine has sparked fears of a recession in 2022.

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Many experts have warned of a recession in 2022. The U.S. economy went into a recession in 2020 after the 11-year economic expansion, which was the longest in history. Here's how to invest before a recession.

Some indicators point to a recession.

Some of the indicators have been giving a recession warning. For example, Paul Hodges, the founder of New Normal Consulting, thinks that falling petrochemical prices signal looming inflation. The U.S. housing market has also slowed down. The yield curve inversion is one of the most credible recession indicators.

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Some of the brokerages also see a recession on the horizon. Goldman Sachs thinks that there's a 35 percent probability of a recession over the next two years. John Mauldin, who correctly predicted the 2000 and 2008 crashes, is even bearish and expects a recession in 2022. In the April BofA global fund manager survey, 26 percent of the fund managers said that a recession is the biggest tail risk for markets.

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San Francisco Fed President Mary Daly said that while she doesn't think a recession is imminent, it's a possibility. Fannie Mae also sees a recession in the back half of 2023 and expects the U.S. GDP to contract 0.1 percent in the year.

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Why is everyone worried about a recession?

Several factors are fueling recession fears. First, given the multi-decade high inflation, consumer spending on discretionary items is expected to fall. To make things worse, rapidly rising mortgage rates will lower the disposable money in households. The Russia-Ukraine war is also adding to uncertainty in the markets.

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A recession isn't imminent. Morgan Stanley doesn't think that the U.S. economy is heading for a recession. However, given the rising fears, it might be prudent to position your portfolio for a possible slowdown in the U.S. economy.

Here's how to invest before a recession.

First, you should remain calm. A recession is as much a part of the economic cycle as cyclical booms. Amid rising interest rates and slowing economic growth, it would be prudent to look at your asset allocation.

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Given the expected recession, you might want to somewhat trim your exposure to stocks. Within stocks, you can shift towards value stocks. In the tech space, investors might be better off in mature and established names like Alphabet and Amazon than loss-making tech companies.

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If you require any funds from your portfolio over the next five years, ideally it shouldn't be in stocks but in low-risk instruments. Given the rising interest rates, floating rate bonds can be a good avenue to park funds with a horizon of above one year. Also, make sure that you have some cash savings equivalent to six months of expenses since a recession invariably leads to job losses.

Looking at the inflationary environment, you can make some allocation towards I bonds. Their yields are tied up to the CPI inflation and investors can expect good returns at least over the next year.

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Investors should consider an increased allocation to gold.

Amid the economic and geopolitical turmoil, you can increase your allocation to gold. Gold can outperform in a recessionary environment and barring rising interest rates most other factors are supportive of gold prices.

Investors should avoid certain investments ahead of a recession.

It's always better to avoid speculative and penny stocks before a recession. These stocks have fallen and more pain could be ahead if we head towards a recession.

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