The Idea of Staying Recession-Proof

Before you decide to invest in anything during or before a recession, you need to have one clear idea of risk in your mind - recession is a systematic risk. And because it is a systematic risk, you cannot diversify your portfolio of investments to mitigate this risk. That means, you cannot escape a recession completely unscathed.

Most modern economists cite deflation to be the starting point for recession. Over capacity leads to less profits, which leads to less spending, and thus the layoffs. This usually spirals into a domino effect leading to a period of recession. Even if you have considerable investments, the societal tensions might lead to a situation where there is recession with high inflation, called stagflation. In such a scenario your ability to purchase products and services diminishes.

In addition to this, such turbulent economic situation causes liquidity related risks, which renders your asset to have value on paper, but not so much so in the real world, as you have no buyers of your assets.

With that clear and out of the way, I believe cash is king during recession. If the inflation is high but within a certain limit, cash eliminates liquidity risk and other transaction related operational risks.

The following list shows how major investment instruments behave during times of recession:

1. Cash is still the most liquid asset that holds value for accquiring products and services

2. Stock markets are down, so you do not expect to see cash flow come in for you from there

3. Corporate debt markets become more prone to default as many companies report bankruptcy

4. Government bonds still are bound to make payments, so they are comparatively safer

5. Mutual Funds invested in safe assets like Government bonds are safer when compared against the growth stock invested MFs

6. Foreign exchange is attractive if you hold other safer currencies (like the US $), as the demand for these reserve currencies rise during such periods

If you are an ordinary individual investor, the best you can do at such times is to hold cash. Once you feel recession has set in but not firmly, register small losses, and convert your assets into liquid cash. This will offer you the best protection during a recession, even if the monetary system gets shaken up a bit.

Forex can be held, but remember, with worsening recession, the transaction risk associated with it increases manifold. If you are an ordinary investor in the forex market, chances are, you will not be able to hold the position in such times of crisis. So steer clear of it, unless you have a clear idea of what you are getting into.

The exit strategy for the recession period, is based on the central bank’s intervention. If you see that the Government and the central bank shift the risks from the companies and individuals to themselves, it’s time to reduce cash and get back to market based positions. The market will be cheap so buy in some marquee stocks, bonds and foreign currencies. You might need to hold them for some time to register the gains, but they will surely be due, if the intervention and mitigation measures of recession are adequate.

I hope my article helps you find relief if such a dire situation, God forbid, ever arrives.

P.S.- Do note that a lot of individuals feel that they should take more and more positions in the market as situations worsen, as assets become dirt cheap, and they can earn tons of money from these assets later. But remember this kind of an approach is only possible if you have considerable savings already, which for most individual investors in not the case. Remember you can fight tomorrow only if you survive the battle today.

Happy investing!

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