Recession Investing And The Housing Market

Why could the U.S. be heading into a recession? The most likely reason is the housing market- a multi-faceted subject. There’s the new home building sector.

It’s important because it employs so many people, not just in construction but, by extension, in the industries that supply materials to the homebuilders – lumber, concrete, appliances, and even retailers like Home Depot.

Think about all the “stuff” that goes into a home and how much you buy when you move. A slowdown (or collapse) in new home building has a ripple effect throughout the economy and could drive up the unemployment rate.

Housing market problems are not limited to new home sales. The value of your home and the market for sales of existing homes is falling. By how much and for how long is the big question. But the problem here is the equity we have in our homes is evaporating.

Even worse, those of us who have recently purchased homes or have taken money out of our homes, through refinancing or home equity loans, may have no equity left. A reduction in home values reduces homeowners net worth, causing them to pull back on spending.

The mortgage market mess is the last, but the not least, of the housing market issues. The big problem is not subprime mortgages, it’s adjustable rate mortgages. Bumps in mortgage payments due to contractual provisions or an increase due to a rising LIBOR rate – most mortgages are tied to this rate and it may rise even if interest rates fall in the U.S. – will force consumers to cut back spending in other areas. Lastly, will more stringent lending standards exacerbate the new home construction and/or existing home value problems?

There are other economic concerns as well – consumer spending (beyond the impact of the housing market), rising energy prices, the U.S. balance of trade deficit (are jobs being exported as a result?) So, if you’re concerned about the possibility of a recession, and who shouldn’t be, how do you invest?

The stock market, according to classical wisdom (or folklore) anticipates a recession by six to nine months. Since it’s currently at record highs (at least the Dow and S&P) this suggests a recession is not in the offing. But the market could change direction at any time. There’s a saying that the stock market has predicted ten of the last five recessions.

So maybe it’s not such a perfect predictor after all. The stock market also anticipates economic recoveries. Add to the mix the psychological difficulty of investing in stocks when things are the bleakest (the best time to buy) and it demonstrates the difficulty (impossibility, for most of us) of trying to time the market.

Most investors should be in the stock market to take advantage of growth in principal value and income which comes through the long term ownership of equities. Stocks which do best in recessions are those of the strongest companies and companies whose products consumers must keeping buying (think toilet paper not cars).

The stocks to focus on are big cap companies, consumer staple products and health care. There’s an overlap between many big cap stocks and consumer staples and health care companies. I’d also add to this list companies with significant international sales. (Did you know that a majority of McDonald’s, and many other U.S. companies, sales are overseas?) There’s also a substantial overlap between big cap and international sales. You can find many good mutual funds which focus on these areas.

Will this investment strategy provide a positive return during a recession? Not necessarily but it will keep you in the stock market with a minimum amount of risk and the long term investor will be well positioned if there is no recession or for the upturn in stocks after the recession occurs.

What about bonds, you ask. Don’t they do well during a recession? Yes, if interest rates decline as a result, but that may be occurring just when stocks are beginning to rally again.

With long term U.S. Treasuries yielding below 5% (some good money market accounts have higher yields) how much lower can interest rates go, so how much higher could bond prices go? Focus your risk-taking investments on the stock market and keep the rest of your capital in cash.

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