Profiting In A Recession 101
by Freddy Espinoza
March 1, 2010
Sure, this might be way to early to prepare for, but for those of you who believe in a “double dip” it might not. I won’t debate whether the next recession will start in a month or in 50 years, but two quarters of GDP growth sounds like the end for the “Great Recession.”
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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Juan Carlos Armenta March 2, 2010, 9:27 pm
Freddy, let me say right from the start i do sincerely find your ideas and portfolio up to par with profitable success. Unfortunately, common people thrive only in the speculation that giant companies and corporations may bring the biggest shares and therefore the bulkiest profits, but what we have inherently failed to consider is the basis of economic competitiveness. What i mean by that is the forgotten notion that drives our economy, that hidden infatuation that silently empowers economic stability, the only good thing that follows the invariant decline of huge conglomerates is the idea that as one falls, it may give rise to another, as one fails another may take its place. For what is capitalism without its competitors fighting for survival? True, GM and other bankrupt corporations hurt this economy and even damaged our belief in the capitalist system, but what we have failed to see is: What will rise now? What may profit from these damaging crashes? Well, the new dark-horse powerhouses ready to inherit our trust and as you described in your article, it is in them that we must invest. The federal government has made it safe for us to take new risks and enjoy the advantages of its lowered interest rates so as of right now, it is up to us to consistently, but securely profit from this ending recession.
Me April 8, 2010, 12:53 pm
It is true that we should not pay for other’s mistakes; but think of the consequences if no bailouts would have taken place. AIG, BofA, and Citi would have all failed. Foreign investors (including BoE, europe hedgies, and probably BoJ) would have gotten tremendous deals on the failed institutions and they would own most of our financial system. Then we would be working for foreigners. our dollar would most likely depreciate so much (due to high unemployment) and we would become a manufacturing country in the long term (due to a cheap dollar, foreigners would take advantage and produce here). and we would America would not be a viable investment since many investors did not get paid when their investments were in the money. With the government reaping billions of dollars in profits due to equity deals involved in the bailout, its not a bad idea after all. Think of Chrysler in the 80’s; they got a bailout and the government had a 20% return…