Recession Investing: Where to Invest When the Market is Going Down.

It isn’t a secret that the overall economy is entering into a rough patch. The declining housing market, poor retail sales, and overall debt are breaking the back of the economic machine that is the U S of A. As an investor, what can you do to protect your wealth during these hard times? First, let us look at how a few sectors did in 2007:

January 1, 2007 – December 31, 2007

Gold: 34%+

Euro: 12%+

DOW: 6.4%+

S&P 500: 4%+

NASDAQ: 9.1%+

This is all well and good but how are these sectors now doing considering that we had a very tepid holiday shopping season and now the housing market is in full crisis mode and people are openly talking about recession? Let us take a look at year to date performance:

January 1, 2007 – January 13, 2008

Gold: 6%+

Euro: .537%+

DOW: -4.96%

S&P 500: -4.59%

NASDAQ: -8.01%

In this context, practically all the gains of 2007 were wiped out for the DOW, S&P, and NASDAQ in the first 2 weeks of 2008. If you were heavily invested in real estate or financials your portfolio took a much larger hit. It is important to recognize that investing in recessions is very different and requires the ability to rebalance your portfolio. I would venture to say that we will see continued pressure on the major indexes and would not be surprised if we see major losses in 2008. Why will there be continued pressure? Here are a few reasons:

1. The Housing Market

It goes without saying that there is major excess in the housing market that needs to be purged. Home prices last year saw their first annual median decline since the Great Depression. While certain areas in the south avoided the bubble altogether certain areas such as California and Florida will see major corrections as the easy credit is flushed out of the system. If you are invested in real estate or financial in your stocks, you really need to think twice about what you are going to do about that for 2008.

2. Job Losses

With a declining economy job cuts in construction and real estate related industries are going to be steep. There are estimates that for the past decade, about 30 percent of all added employment was somehow related to housing. Whether it was Home Depot or Lowes to Black and Decker and mortgage brokers. With the unemployment rate surging to 5 percent last month we can expect this trend to continue as the credit market and the housing sector contract.

3. Weak Consumer Spending

There is a major wealth effect when housing prices are healthy. Consumers feel richer because their homes go up in value. This perceived added value pushes them to spend. And from many estimates the American consumer is 72 percent of the economy. So with the weak holiday numbers and continued credit contraction, the American consumer is spent to the max. This will only continue as we are seeing and even giants like American Express have announced poor numbers.

Where does one Invest?

This is really the million dollar question. I believe that gold and the Euro will continue to do well in 2008. Why? For one, gold does well on perceived inflationary pressures and even in deflationary environments. With the Fed signaling that they are going to take “substantive” action to reduce the risk of economic problems, it is clear that they are going to cut interest rates which is only going to devalue the USD and make gold more attractive simply because of the fall of the dollar in relation to gold. Also, for this same reason the Euro should continue to appreciate in the face of current conditions. What you can do as an investor to balance out your portfolio is to buy the gold ETF GLD. No need to buy bullion although this is the preferred method. In regards to the Euro and other foreign currencies, you can open up a global checking account and start saving some money in foreign currencies. Unless the Fed demonstrates that they are concerned about the dollar gold and the Euro will rise. All evidence is pointing toward a serious recession and the Fed is worried about keeping the system running so it is highly unlikely they will raise rates even if the CPI takes a jump up and starts showing signs of retail inflation (which it already is).

You can also take a small portion of funds and buy put options on certain sectors. With some puts you can buy up to 1 year out. You can use this as a hedge against a severe market drop. Buying put options you are only out the premium plus any charges for purchasing the contract. A contract controls 100 shares of a certain stock. For example, you buy 1 put contract of XYZ for $100 and the strike price is 8. Let us assume the stock drops to $6. So now you have $8 – $6 minus any commissions for the sale = approximately $2 x 100. So you nearly doubled your initial investment of $100 to $200. If the stock goes up to $9 your option expires worthless and you lose all of your $100. Option trading is risky and this is a topic that needs to be further investigated before investing but it does makes sense as a portion of your investments especially in a market where very few sectors are going up.

What concerns me is how many people with their 401(k) or IRAs have so much money allocated to index funds and think all will be okay if they simply leave their funds and do not touch them. Let us assume the above scenario and use the data from the 3 indexes. If you started investing in 2007 all your gains have been wiped out. You may think to yourself this is better than losing money but in effect, you have. The dollar during this same time period dropped and inflation kept increasing thus eroding your purchasing power. Unless you returned 7 to 10 percent, you are in the red.

I’m not encouraging you to take all your money and buy gold or buy all put options but these are 2 of many strategies for investing in the current climate. People that do not have 20 to 30 percent of their portfolio in bear investments will be sorely disappointed in 2008.

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