One of the most important things to watch for as an investor is when there is a market or economic ‘shift’. A shift from growth to value, for example, can be devastating to you if you are loaded up on high-tech growth stocks. Similarly, a shift in inflation can totally kill an investment plan.
We may be entering a shift in the economy right now. Companies are guiding to lower growth. Stocks have been weak. The market is in a slow train-wreck crash. The Fed even has indicated the economic party may be winding down.
So, what to do? As always, time frame is important, and diversification will help you get through this. But there are also some specific areas to focus on. Let’s look at five.
Dividend stocks really got beaten up over the past year, as investors anticipated higher and higher interest rates. Even classic ‘widows and orphan’ stocks such as BCE Inc. (BCE on TSX) and Enbridge (ENB on TSX) have fallen, down 5 per cent and 9 per cent, respectively, this year. Suddenly, though, investors are now seeing the end of rate hikes, with the Fed and the Bank of Canada concerned about slowing growth. Those income stocks everyone hated this year? They are likely to come back into vogue quickly. Depending on how the economy plays out, dividend stocks, REITs and royalty plays might do much better in 2019.
Don’t ignore growth
In a slowdown, growth will still be rewarded, but reliable growth is what investors will be looking for. Heaven help those companies who miss earnings expectations in this market. You can still be a growth investor, but you need to be more careful. Look for companies with strong balance sheets, strong market share, and pricing power. Watch your valuation multiples. A growth stock at 75 times’ price-to-earnings is going to be more vulnerable in a weak market than a growth stock at 35 times’ price-to-earnings. Better still, look for a growth company with a 20 times’ price-to-earnings valuation.
Recessions, even if one is about to start, are not usually that bad. Right now, investors are worried about the inverted yield curve, which has predated almost all recessions of the past 50 years, with only one false positive. But what investors don’t realize is that markets, on average, have done very well during the period after the first yield inversion to an ‘official’ recession. Looking at five recessions back to 1978, there was an average of 21 months from inverted yield curve to a recession, and the S&P 500 rose an average of 12.7 per cent during that average period. In 1988 to 1990 the market rose a solid 28 per cent even as the U.S. economy lurched towards recession. What does this mean to you? First off, don’t panic. If you want to change your portfolio to be more defensive, you have lots of time. Second, maybe you don’t even need to do anything. Most recessions are very short anyway. Third, don’t ignore the markets: there will still be lots of opportunities to make money, even in a lead up to a possible recession.
In a defensive market, consumer staples (think Loblaw, Premium Brands, Saputo), utilities (Alqonquin Power, Brookfield Renewables) and telecom (think the aforementioned BCE, Telus and Rogers Communications) tend to do much better. In a nervous economy, investors want the reliability of consistent cash flows and they want businesses who may be recession-proof. After all, who is going to give up their cellphone in a bad economy? Even those perhaps soon-to-be unemployed workers need a phone to secure a new job.
As can be seen, painfully, from the cannabis sector these days, now is not the time for investors to gamble. When rates and/or the economy changes, uncertainty abounds. It is not the time to take a flyer on an overly valued, money-losing company. Cannabis, blockchain, speculative miners, and so on, are not going to perform well in a weak market environment. When investors are scared, smaller companies get sold first. If you plan on raising cash, sell your speculative and small companies first. These can get very ugly in a market declining on economic worries.
This all sounds negative, of course. There is always a chance the economy keeps growing, and a ‘soft landing’ keeps the market on course for more long-term gains. Time will tell.
Peter Hodson, CFA, is Founder and Head of Research of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (http://www.5iresearch.ca).