Recession Fears Are Back. These 3 Steps Can Prepare Your Investments for a Bear Market
Key Points
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Despite many material risks, the market remains near historical highs.
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Notably, the Fed is attempting to fight inflation with the blunt instrument of interest rate increases.
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If higher interest rates trigger a recession, a bear market could be on the way.
If you simply looked at the lofty level of the stock market, you’d think that the world was in great shape. Only, it isn’t. There are multiple geopolitical conflicts raging. Leverage is high even as companies take on massive debt in the rush to build artificial intelligence infrastructure. And inflation is running hot.
Inflation is an interesting risk right now because the U.S. Federal Reserve appears to be embarking on a cycle of rate increases. That’s a blunt tool, at best, and too many rate increases could easily tip the U.S. economy into recession. Bear markets often accompany economic downturns, so investors should probably start preparing now, just in case. Here are three steps you can take.
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1. Assess your risk tolerance
The first step in preparing your portfolio is to take a realistic look at yourself. If you have been investing long enough, you may have lived through the Great Recession or the dot-com bubble. If you have, you already know what it is like to watch the market get cut in half. And you’ve seen what that means for your personal investment approach. If you haven’t had the “pleasure” of such an experience, consider how losing half of your wealth in a 12-to-18-month period would make you feel.
The answer is likely to be very scared. The big risk, however, is that your fear will lead you to make rash, emotionally driven decisions. And that could derail your long-term investment plans. If you believe you’ll be cool as a cucumber, don’t worry about changing anything. But most investors will probably want to make some changes before the next bear market hits.
2. Let cash accumulate
To be fair, a bear market isn’t the end of the world. Bear markets are just part of investing, and every bear market in history has been followed by a bull that took the market to new highs. So, selling everything and hiding in cash probably isn’t the right decision. In fact, for many, just sitting tight and sticking to a well-thought-out, long-term investment plan is probably the best choice.
But it wouldn’t hurt to accumulate a little cash, just the same. You could accomplish that by not investing any new money in stocks, keeping it in cash, or taking profits from winning positions. That cash will provide some stability during a downturn and give you the firepower to step in when others are making fear-driven decisions, which often result in indiscriminate selling. And the worst thing that happens is there’s no bear market, and you hold onto a little extra cash for a bit.
3. Shift into historically resilient businesses
Another option is to make subtle shifts to your sector allocations, perhaps moving money out of high-risk technology stocks and into sectors historically viewed as recession-resistant. Consumer staples and utilities are two solid choices, as both sell things that people really can’t live without.
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For example, everybody needs to eat and drink. A stock like Coca-Cola(NYSE: KO), while selling a premium product, has proven incredibly resilient over time, as evidenced by its status as a Dividend King (with over 60 consecutive annual dividend increases). The company is performing well today despite industry headwinds, offers an above-market 2.4% dividend yield, and looks fairly valued, with a price-to-earnings ratio roughly in line with its five-year average.
NextEra Energy(NYSE: NEE) could be a good utility option. It is one of the world’s largest utilities, operating regulated utility assets and one of the world’s largest contract solar and wind power businesses. It is benefiting from robust electricity demand and leaning into it with its proposed acquisition of peer Dominion Energy(NYSE: D). The dividend yield is 3.2%, backed by more than 30 annual dividend increases. Notably, the average utility’s yield is 2.8%, so dividend lovers will probably find NextEra Energy quite attractive here.
Prepare now for the fear that a bear market brings with it
Of all of the steps, step one is the most important. You don’t want to wait until a bear market has arrived to think about what you want to do. At that point, your emotions will be running high, and you are more likely to make decisions you may later regret. Meanwhile, steps two and three, raising cash and making defensive investments, can help you stay the course. And that should eventually let you benefit from the lessons of history: so far, every bear has been followed by a bull as the market moves steadily higher over the long term.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends NextEra Energy. The Motley Fool recommends Dominion Energy. The Motley Fool has a disclosure policy.