How To Recession Proof Your Portfolio
Wednesday, January 16, 2008SUSIE GHARIB: On Wall Street, there's still considerable debate on whether the economy is just slowing down or heading for an all out recession. Nevertheless, many individual investors are bracing for the worst and wondering what to do with their portfolios. Suzanne Pratt got some answers from market pros.
SUZANNE PRATT, NIGHTLY BUSINESS REPORT CORRESPONDENT: All of the recession talk has put stock markets on edge and it raises questions for investors about their 2008 strategy. Simply put, recessions are bad for stocks. And there's little reason to believe this time will be different. Still, UBS strategist Mike Ryan says it's not a good idea to stay only in cash.
MIKE RYAN, CHIEF INVESTMENT STRATEGIST, UBS WEALTH MANAGEMENT: What we don't want to do is simply advocate extreme strategies where people just completely move to the sidelines because then what happens is you often find it difficult to re-enter the market. As the market starts to rally, people wait for another pullback and then what happens is you wind up chasing the market higher and people often miss the opportunities as they sit in cash.
PRATT: Ryan says investors should consider recession proof areas of the economy such as healthcare and consumer staples. He also likes U.S. companies that are well-positioned for overseas growth as he does not expect all world economies to follow the U.S. into recession. Strategist Scott Fullman also likes American firms that sell a lot of products in foreign countries.
SCOTT FULLMAN, DIRECTOR OF INVESTMENT STRATEGY, I.A. ENGLANDER: We like the international, diversified companies, big companies, conglomerates that have exposure around the world but, also have products that are needed and will continue to be needed even in an economic slowdown.
PRATTT: While history is no guide to future performance, investors might want to consider how segments of the market have performed in past recessions. According to Standard & Poor's, in the 11 recessions since World War II, there have been few places for investors to hide. On average, all sectors in the S&P 500 declined. On the industry level, however, three groups posted positive returns, including tobacco, household products and alcoholic beverages. S&P's Sam Stovall says there's a reason why these companies do well even in a downturn.
SAM STOVALL, CHIEF INVESTMENT STRATEGIST, STANDARD & POOR'S: If the economy is growing or contracting, you basically still have to eat, smoke and drink. A cynic would actually say that during tough times you are going to eat, smoke and drink more than you normally would.
PRATT: Not everyone is convinced that a recession is on its way. But, experts say the safe bet for investors is to assume that one is and plan accordingly. Suzanne Pratt, NIGHTLY BUSINESS REPORT, New York.
KANGAS: Plagued by growing recession worries, stocks on Wall Street failed to stage even a technical rebound from yesterday's battering. A rise in December consumer prices and Intel's after-the bell earnings shortfall we told you about yesterday kept sellers very active as the Dow fell 95 points by 11:00 a.m. with the NASDAQ off 48 points. After see- sawing for a few hours, the Dow rallied to a 75 point gain on some bargain buying, but a late sell off sent stocks lower by the final bell. The Dow Industrial Average closed off 34.95 at 12,466.16. The NASDAQ Composite ended down exactly 23 points at 2394.59. Standard & Poor's 500 down 7 3/4 points at 1373.20. In the bond market, the 10-year note fell 16/32 to 104 5/32, putting the yield at 3.74 percent.
GHARIB: As we reported, a down day in the bond market. But investors are still looking at bonds as a safe harbor, in view of all the worries about a recession. We turn to a bond expert tonight for his analysis, Jonathan Lewis, chairman of the investment committee at Samson Capital Advisors. Hi, Jonathan.
JONATHAN LEWIS, CHAIRMAN OF INVESTMENT COMMITTEE, SAMSON CAPITAL ADVISORS: Hello. How are you?
GHARIB: So, tell us. The big question is how do bonds do in a recession?
LEWIS: Typically speaking when the Fed is still easing, bonds in fact can do reasonably well. The trick here at this moment in time for people who are worried about how to play the future is the bond market has in fact already discounted quite a lot of recession risk. Treasury yields have fallen quite sharply. So one of the real opportunities here for individuals is municipals. Municipals are extremely cheap right now. And municipal bonds, particularly in the three to seven-year part of the maturity structure are actually yielding more than Treasuries. And for municipal bonds to yield more than Treasuries is an extremely rare opportunity.
Suzanne: So let me ask you. There are so many bonds to choose from. So you're saying, OK, municipals are one option. What about Treasuries or corporates or high yield bonds? What's your recommendation there?
LEWIS: Well, for people who are worried about a recession and are worried about an uncertain environment, the lower you go down in the credit spectrum, the lower you go credit rating wise, the more risk you take on. And so for tax-paying clients worried about risk, paying taxes on corporate bonds or high yields may not make sense when you look at those yields after tax. That's where municipals are such a unique opportunity. In theory, they should yield less than Treasuries. Treasuries are taxable and municipals are not. But they're yielding 110 percent of Treasuries in some maturities which is very cheap. It's a win-win right now for individual investors.
GHARIB: There's a lot of talk or at least some talk now about stagflation, slow economic growth linked up with high inflation. If we do have a stagflation economic environment does that throw a monkey wrench into bond investing?
LEWIS: Stagflation throws a monkey wrench into all investing, unfortunately. A stagflation environment which we haven't seen in some time with slowing growth and rising inflation rates presents problems for stocks as well as bonds. The positive for bonds in a stagflation environment is they're likely to hold up better than other high risk asset classes. I get back to municipals because they're so cheaply valued now that if yields go down, they'll go down pretty far too but if yields on Treasuries start to go up, these bonds are so cheap they'll hold their value better. So that's one safe place to go.
GHARIB: What about these TIPS, those inflation protected Treasuries? Should investors pay more attention to TIPS?
LEWIS: Well, definitely because again in an environment that we've had where there's a lot of volatility and price movement you want to look at parts of the market that perhaps appear cheap on some bases. Regular Treasuries have had a flight-to-quality environment. They've gotten overpriced relative to where the Fed may move next. TIPS, while they've had a pretty big move too, are still discounting a very low level of inflation, about 2-2 1/2 percent. So if you as an individual believe inflation is going to be higher than 2 or 2 1/2 percent over the next couple years, TIPS can still offer some value. They are taxable. So of course you want to put those in some sort of a tax-sheltered vehicle.
GHARIB: You're also a portfolio manager. So here's a portfolio question for you. Is there a rule of thumb of what percentage of a portfolio should be in bonds in this kind of environment? Again this is for individual investors with a long-term horizon who are risk averse. Can you give us a quick guidance on that?
LEWIS: That's a question I get frequently. Unfortunately it's one of the toughest questions in the world because each person is very different. Their sense of risk is different, even the conservative client. The real way for someone to figure this out is how much can they stomach? How much pain and how much do they think the stock market will go down from here? If they think the stock market can go down a lot from here, well then they need to have a lot more in bonds. And then there's a mathematical equation that one can think through that says if the stock market is going to go down 20 percent from here, I could afford less and less in stocks if I want my overall portfolio to hold up.
GHARIB: All right. We'd love to hear more, but we got to leave it there. Jonathan thank you so much for coming on the program (ph).
LEWIS: Thank you for having me.
GHARIB: My guest tonight, Jonathan Lewis, chairman of the investment committee at Samson Capital Advisors.
