Protection against economic downturn, recession or stock bubble burst

[dice]

At the moment many markest seem quite high, some with the possibility of recession looming.

Taking a ETF based approach what are your opinions on preparing a portfolio for the possibility of
i) a recession or
ii) a significant market correction.

Being more specific I think a possible strategy to protect against a US recession might include weighting towards steady sectors such as healthcare. I have heard arguments for soft comodities - as they are less volatile than hard comodities.
One area I am particularly interested in opinions on is investing in ETFs that concentrate on Value or Growth - would these be less likely to be affected during a recession than a plain S&P 500 tracker for example?

On a global sheme what regions/countries and sectors are least likely to be affected by a US slowdown? And what markets would be least affected by a significant chinese correction?

Hopefully this can kick off some debate on the pros and cons of various approaches.

 

[room305]

The best protection against a recession is cold hard cash. The worst would be growth companies (what is a recession only the curtailing of economic growth?) or commodities of any ilk hard or soft.

Don't worry too much about people trumping a significant market correction. For as long as you hear such proclaimations being made regularly the markets are pretty safe.

You should only start to worry when things have never looked better and nobody can see any reason for the markets to falter.

Things always look best at the top ;-)

 

[dice]

The best protection against a recession is cold hard cash.

What? no mention of Gold?

The worst would be growth companies (what is a recession only the curtailing of economic growth?)

I guess so - but shouldn't Value companies offer some protection?

or commodities of any ilk hard or soft.

I would have thought that agricultural produce would always be in demand and would be classed as a soft commodity - though I have to admit that I'm still getting to grips with classifications of sectors/produce etc.

Don't worry too much about people trumping a significant market correction. For as long as you hear such proclaimations being made regularly the markets are pretty safe.

Still, I would say even you have concerns about The China Bubble

 

[room305]

What? no mention of Gold?

Gold does not always perform well in a recession. It's not always 1979.

I guess so - but shouldn't Value companies offer some protection?

Indeed they should (I hope). It is by no means guaranteed and value stocks and growth stocks are not always one and the same.

I would have thought that agricultural produce would always be in demand and would be classed as a soft commodity - though I have to admit that I'm still getting to grips with classifications of sectors/produce etc.

A recession usually entails less demand for most goods and services, although the demand for some will be hit much harder than others.

Still, I would say even you have concerns about The China Bubble

Indeed. I'm quite bearish on the economy but then I'm pretty pessimistic person. As per my earlier post, get worried when I open "Why the Chinese miracle means the stock markets can only go up" thread ;-)

 

[jhegarty]

The best protection against a recession is cold hard cash.

But on the other hand if hyper-inflation kicked it you will be in trouble...

 

[tyoung]

Growth stocks have historically done better than value stocks in a recession. Growth is currently "cheaper" than value particularly large cap growth. Large caps generally do better than small in a downturn. I think the best risk/reward is in large cap growth. I think at this level(of the dollar) the US is relatively appealing, Japan should benefit if the carry trade unwinds and if you are worried about a downturn go easy on emerging markets.
In terms of sectors recession resistant areas would be healthcare, food stocks, tobacco, drinks etc
The best asset class in a recession are bonds. The price will rise if interest rates fall.

 

[room305]

But on the other hand if hyper-inflation kicked it you will be in trouble...

The OP only asked about an economic recession. Hyperinflation is a fairly unlikely phenomenon in a democratic developed country with an established banking industry.

 

[dice]

Good to see that the views are as wide here as elsewhere - Growth stocks touted as best and worst options.

tyoung: when you say large caps generally do better in a downturn do you mean their share price is affected to a lesser extent or they are affected less as a company than smaller caps? and do you have any links to articles discussing this that might be of interest?

I agree that the level of the dollar is good, despite the thread of further US slowdown, but there seems to be a strong belief that it still has a little further to drop - especially in relation to asian currencies.

Bonds are something I have not yet got my head around - does anyone have links to a really good online explanation that explains how they tend to behave rather than just stating what they are?

tyoung says go easy on emerging markets - and I believe that they could be especially suceptible if the yen carry trade unwinds. These would also be suceptible to the hyper-inflation threat I guess, but even so for a long term outlook I am still inclined to have about 15% of my portfolio aimed at emerging markets. Am I crazy?

 

[room305]

Growth stocks have historically done better than value stocks in a recession.

Please find some evidence to back up this assertion, personally I'm a little incredulous. A defining characteristic of a recession is a lack of economic growth and business investment. Not exactly an environment where a growing company thrives.

Growth is currently "cheaper" than value particularly large cap growth. Large caps generally do better than small in a downturn. I think the best risk/reward is in large cap growth.

What? Surely if a company is overvalued it is no longer a value stock.

I think at this level(of the dollar) the US is relatively appealing, Japan should benefit if the carry trade unwinds and if you are worried about a downturn go easy on emerging markets.

Believe me, the BoJ will fight any unwinding of the carry-trade as much as possible. They do not want a strong Yen and they do not believe Japan will benefit from it.

 

[tyoung]

Growth stocks are defined as those with above market average earnings growth. Growth stocks tend to be in rapidly growing sectors or else hold a niche in a slower growing sector. Their earings growth is usually NOT dependent on overall economic growth.
On the other hand value stocks are those with below market earnings growth. They tend to be in mature sectors or mature companies in rapidly growing sectors. They tend to be highly leveraged to the economic cycle.
Compare British Airways and Ryanair. Throughout the 90s and 00s Ryanair was the classic growth stock and BA was the value play. In the downturn after 9/11 which company was able to shrug off the downturn in air travel and increase profits every year?(RYA). Which of the two fell into a loss in 01 to 03?(BA)
On the other hand which has done better in the upturn that happened since( 03 to 06)(BA!).
Because of their better earnings growth outlook Growth tends to be priced on a higher P/E, Price/Book(NAV) and price/sales. However occasionally when value stocks outperform growth their valuation may come closer than the historical differential. I believe than has occured at present which is why I said that growth was "cheaper"than value.
Finally in general bigger companies tend to to do better in a downturn than smaller companies mostly because they have more resources. If the s... hits the fan which would you rather own CRH or Kingspan?", AIB or Anglo irish?
In summary I think large cap growth offers a relatively defensive way to play the market if you are worried about a downturn. Of course if you are REALLY worried you should be in cash and bonds.

 

[room305]

Growth stocks are defined as those with above market average earnings growth. Growth stocks tend to be in rapidly growing sectors or else hold a niche in a slower growing sector. Their earings growth is usually NOT dependent on overall economic growth.
On the other hand value stocks are those with below market earnings growth. They tend to be in mature sectors or mature companies in rapidly growing sectors. They tend to be highly leveraged to the economic cycle.
Compare British Airways and Ryanair. Throughout the 90s and 00s Ryanair was the classic growth stock and BA was the value play. In the downturn after 9/11 which company was able to shrug off the downturn in air travel and increase profits every year?(RYA). Which of the two fell into a loss in 01 to 03?(BA)
On the other hand which has done better in the upturn that happened since( 03 to 06)(BA!).
Because of their better earnings growth outlook Growth tends to be priced on a higher P/E, Price/Book(NAV) and price/sales. However occasionally when value stocks outperform growth their valuation may come closer than the historical differential. I believe than has occured at present which is why I said that growth was "cheaper"than value.

I don't agree with your assertion that growth companies grow independently of economic conditions, it seems counterintuitive. Your definition of mature companies and value companies seems interchangeable, which of course they shouldn't be.

Though definitions are by their nature always subjective, in the broadest sense I tend to go along with William Bernstein's assertion that

"Looking for cheap stocks is value investing. The opposite of this is growth investing."

Also when I overlay charts of BA and RYA, It doesn't correspond to what you are suggesting here. I just see massive outperformance by RYA. Not that it would prove anything anyway.