The US economy slipped into a technical recession after consecutive quarters of negative GDP growth in the first half of 2022, as rampant and widespread price inflation hit businesses and consumers.
Looking ahead to 2023, economists and market analysts agree that the country will begin to experience the real pain of an economic downturn. While experts may debate the size and scope of an economic downturn, how can households and investors protect themselves from storm clouds? This is what the typical person wants to know.
Defensive Sectors and Dividend Investing
First, which sectors should be on your radar?
Last spring, Goldman Sachs published its recession handbook to help prepare clients for a recession. The document noted that in the five recessions since 1981, the top four sectors have been consumer staples, energy, health care and utilities.
Meanwhile, higher interest rates have made high-yield savings accounts, money market funds, and certificates of deposit (CDs) more attractive. However, with the real (inflation-adjusted) interest rate still negative, it might not be enough to protect families’ net worth.
This is where dividend investing comes in, as it can generate passive income.
A dividend is a distribution of a company’s profits to shareholders that is paid monthly or quarterly. For example, PepsiCo’s annual dividend yield is 2.66 percent, which means it pays investors $1.15 per share every three months.
There are several types of dividend stocks on the US stock market, including dividend aristocrats and dividend kings. The former are companies that have increased their dividend payments for a minimum of 25 consecutive years (Exxon Mobil, Target Corp. or Walmart). The latter are companies belonging to the S&P 500 that have increased their dividends for at least 50 years (3M, Coca-Cola or Procter & Gamble).
“Dividend growth stocks tend to be of higher quality than those in the broader market in terms of earnings quality and leverage,” S&P Global analysts wrote in a document (pdf). “Simply put, when a company is able to reliably increase its dividends over years or even decades, this may suggest that it has some financial strength and discipline.”
The Bonds of the Name, Bonds I
In the current inflationary environment, one of the most popular investment tools has been inflation-protected bonds, or I-Bonds. The other popular vehicle is Treasury Inflation Protected Securities (TIPS).
As everyone explores tools to hedge against 40-year high inflation, investors have been using these two types of bonds to their advantage. TIPS became attractive when they began offering an interest rate of 9.62 percent in May.
They became popular because no other bond investment offered such high interest rates. When investors factor in volatility and uncertainty, it becomes “a no-brainer,” according to Mel Lindauer, founder and former president of the John C. Bogle Center for Financial Literacy.
But what is the difference between an I-Bond and TIPS?
The principal sum of TIPS is adjusted to integrate the current rate of inflation. I-Bonds receive an interest rate adjustment to reflect inflation. In the meantime, paypayments are correlated with the CPI. If inflation rises, CPI-linked bonds will increase payments to holders. If the CPI goes down, the payments will also go down.
Investors can open a Treasure Direct account and purchase a maximum of $10,000 per year. Or they can buy bond funds on the open market, such as Fidelity’s Inflation-Protected Bond Index Fund (FIPDX) or Vanguard Inflation-Protected Securities Fund (VIPSX) investor shares.
Is the US dollar still king?
The US Dollar Index (DXY), which measures the dollar against a basket of currencies, has been on the upswing in 2022, rallying around 14 percent to around 109.00.
The dollar’s strength has been fueled by rising demand for conventional safe-haven assets. Global investors have been fleeing the dollar in response to the Federal Reserve’s tightening campaign, volatility in the equity arena and weakness in other major currencies (euro, yen or Canadian dollar).
Is it too late for investors to dive in or is there more room for growth? Market pundits anticipate a high US dollar for some time, particularly if the global economy falls into recession and the Federal Reserve becomes more aggressive.
There are several dollar-linked funds, with the most popular vehicle being the Invesco DB US Dollar Index Bullish Fund (UUP).
Does the gold still shine?
Gold has been the main safe haven asset in times of chaos. But why has the yellow metal fallen 6 percent to below $1,800 in an inflationary climate and a slowing economy?
There have been two main reasons: the rise in the US dollar and the rise in Treasury yields.
A stronger dollar is bearish for dollar-denominated commodities like gold because it makes it more expensive for foreign investors to buy. Also, gold is typically sensitive in a rising-rate economy because it raises the opportunity cost of holding nonperforming bullion.
But the precious metal could be resurrected if the Fed reverses course and cuts rates in response to a sharp economic downturn.
ETFs for recessions
Since the start of the coronavirus pandemic, exchange-traded funds (ETFs) have exploded in popularity among passive and active investors. They’ve been around for more than three decades, but demand for ETFs has skyrocketed amid tax breaks, lower costs and themed investments. Internationally, the value of assets managed by ETFs exceeds $10 trillion.
While there is an ETF for just about everything in the global economy, is there an ETF to weather a recessionary storm? Market experts often recommend ETFs that specialize in dividend appreciation, consumer staples, food, and low volatility companies.
Here are some of the more popular ETFs that invest in these areas: Vanguard Dividend Appreciation Index Fund ETF Shares (VIG), iShares US Consumer Staples ETF (IYK), First Trust Nasdaq Food & Beverage ETF (FTXG), and Invesco S&P 500 Low ETF. of volatility (SPLV).
Updating investment strategies
Investment experts say that one of the best methods to employ is to update your trading styles.
A common investment tactic is dollar cost averaging (DCA). This is when investors regularly buy stocks or ETFs in roughly the same amounts. By engaging in this practice, retail investors can avoid buying at all-time highs, avoid trying to time the market, and ultimately drive down the average stock price.
Another simple measure is diversification.
During the market euphoria phase of 2020-2021, investors poured into tech stocks, be it Alphabet or Netflix. This might have worked in an easy money environment, but a tighter climate requires diversification. Therefore, an updated portfolio in a recession might include exposure to real estate investment trusts (REITs), commodities, index funds, emerging markets, and bonds.
At the same time, it’s crucial not to overextend a portfolio, making it almost unmanageable for average investors.
Also, many experienced and novice traders make one of two mistakes: timing a bottom or panic sell. Both are risky bets, especially for long-term investors, as they could lose huge profits. Market strategists claim that recessions and bear markets are the best periods to build positions to achieve long-term goals.
“Historically, there are far more up years in investment markets than there are down years,” M. Tyler Ozanne, principal and chief financial advisor at Probity Advisors, told Bankrate.com. “In a recession, and the corresponding negative market environment, it’s good to remember that better investing days are likely ahead.”