As for the long term, many people fear the huge national debt will bring down the dollar creating massive inflation. Fortunately we are not alone! Europe’s countries have also debt problems. Greece has an 115% debt/GDP, Italy has a 117% Debt/GDP, and Italy has a 117% Debt/GDP. According to Bloomberg Japan has a 190% GDP/Ratio. The US dollar Index (^DXY) measures the dollar against a basket of currencies,; according to the index, the euro and the yen are the ones that affect the dollar the most; this index has actually risen over the recession. Continuing a decline in the index from 2005-2007 the dollar rallied in mid-2008 to 2005 highs. Our dollar currently stands at an 81 level compared to the 75 level in 2006; our dollar is stronger than 4 years ago. So where is all the deficit reflecting? Its not since other currencies have debt problems too!

Unemployment rates are also high in other countries with Europe’s unemployment at 10%, Japan at historical highs and U.S. at 9.7% everything seems to move in synchrony, which cancels out the downward dollar pressure, so the dollar should not be affected as much as we think so.

Does than mean China will take over? Emerging economies will continue to develop, but for them to catch up to their GDP growth rate will have to be excessively higher than their population growth rate. They depend on the U.S. economy for many reasons besides national trade (such as trade and financial regulation.)

Unless the most currencies collapse and we return to a gold standard monetary system (extremely unlikely), in the medium term, which is in 1-4 years, the forex movement should move along rising individual currency interest rates. In the long term, that is later than 4 years, we should not notice a big effect on the dollar.

Staying alive in a recession can be done by following common knowledge, stocking up on high dividend utility companies and non-cyclical shares. But why not profit? Shorting cyclical shares sounds good but too risky. There are several ways to profit without shorting.

As signs of a recession appear, investors become risk-adverse; they start adjusting for risk by discounting bigger risk from stocks, lowering shares’ prices. So if volatility is considered a measure of risk, volatility rises therefore option prices increase. Buying out of the money puts sounds like a good idea, building long straddles, that is buying a put and a call at the same strike price, even better. Not into options? With increasing financial products you can find volatility-packaged ETFs such as the VXX. That sounds profitable.

As the saying goes “as GM goes so goes the nation”, lets short automakers! Wait… we said no shorting. If consumers stop buying cars because of the fear of unemployment, they’ll keep their same car; but keeping your old car comes with a price: repairs, part replacements, new tire, AutoZone (AZO), Advanced Auto Parts (AAP), etc. Yup, they profit from it, you should too.

Monetary policy is considered a good way to stimulate the economy. In a recession the Fed is likely to lower interest rates. Since bonds & yields move inversely, buying some t-bills for a short-term profit sounds good. After all, the golden rule is buy low sell high! Even if you get it wrong you keep the interest. Many pros say “don’t turn a trade into an investment”, but its ok to have a fall back plan so go ahead and keep the interest and don’t feel bad.

What I like to call the Ultimate recession portfolio is having 96% of 5% coupon rate treasuries, held to maturity, and 4% options. Considering an increase in volatility, the options can bring huge profits, giving you the upside. Out of luck and the timing was not right? The interest payment from the bonds will keep your portfolio alive (96 *1.05= 100.8), never loosing a penny (interest rate fluctuations ignored since HTM).  With current 10-yr t-bill rates at 3.78% it’s a good idea to wait for interest rates to go up.

Predicting a recession is an art, which apparently many people are not good at it. Knowing what to do once you have spotted a recession is easy by having a recession plan.

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