Some Ways to Weather the Next U.S. Recession

A recession is coming, many economists warn. If, for once, they aren’t crying wolf, will you be ready?

This may be just as good a time as any to begin assessing your personal finances and investments, preparing for when the inevitable slump hits. Many experts warn that a downturn may come later this year or early next year, pointing to recent declines in factory orders and housing starts, sluggish retail sales and flat industrial production.

While these experts have sounded false alarms before, a downturn will come sooner or later; the expansion is now into its seventh year, a peacetime record.

Although there are no foolproof ways to get rich in recessions, here are some general common sense suggestions to conserve what you have in hard times:

- Save up. In normal times, many financial experts say, you want enough cash or cash equivalents to support at least three to six months of living expenses for you and whoever you support. If you think you may lose your job or suffer other financial hardships in a recession, six to 12 months of reserves might be better.

Money market funds and brokered certificates of deposit are simple, safe, high-yielding investments that serve as great cash equivalents because they generally can be converted easily into cash. You also can tap precious metals, collectibles, real estate or other “hard” assets, but in a recession these assets may not fetch as much as you paid for them.

If you still don’t have enough savings, start a forced savings plan through which you automatically set aside 10% to 15% of your income. If you want some of that money to go into stocks or stock mutual funds, use “dollar cost averaging,” in which you invest a set amount at set intervals, regardless of what happens to the market.

“This is sensible anytime, but particularly in a recession,” says Mitchell Keil, a financial planner at IDS Financial Services in Irvine. In a recession, he notes, the stock market tends to be volatile, making “timing” ups and downs difficult even for the pros.

- Cut debt and spending. If saving seems to be difficult, do a cash flow analysis to review your spending habits. List all your income for a given month and then all your expenditures. If the expenses exceed the income, look for ways to cut back.

Also, ask yourself whether you really need any large, discretionary purchases you are considering, such as a new car, boat or vacation home. William F. Brennan, head of the financial planning practice in Washington for the accounting firm of Ernst & Whinney, says he recently persuaded a client not to buy a vacation home. The client will, instead, rent.

As for debt, Brennan suggests as a general rule of thumb that, for hard times, you generally don’t want your annual debt load to exceed 25% of your income. In good times, 33% is appropriate, he says.

If you need help managing your debts and setting up a budget, reputable low-cost credit counseling services are available from Consumer Credit Counselors, a nonprofit organization with 400 offices nationwide. For referrals, call (213) 386-7601 in Los Angeles County, (714) 547-8281 in Orange County, (619) 224-2922 in San Diego County and (714) 781-0114 in Riverside County. Elsewhere, call the National Foundation for Consumer Credit in Silver Spring, Md., at (301) 589-5600.

- Get recession-buster stocks and funds. If you knew the exact timing of a recession, you should get out of equities entirely during the first part. That’s because stocks generally decline in the first half of a recession, then pick up once the bottom passes and investor optimism grows.

In the eight postwar recessions, stocks bottomed on average about 6 1/2 months into the slumps, according to a study by Standard & Poor’s Corp. Those slumps lasted an average of 11 months, meaning that stocks were rising the last 4 1/2 months, on average.

But because even the pros aren’t able to predict an exact middle point--or starting point, for that matter--it’s wise not to try to “time” the recession yourself by selling all your stocks now. Instead, adjust your portfolio to emphasize stocks and funds that hold up better when all else is falling apart.

One good bet would be blue chip stocks that pay high dividends and enjoy relatively stable revenue, such as utilities and food companies. High dividend payments will act as a cushion against stock price declines.

Geraldine Weiss, editor of Investment Quality Trends, a La Jolla newsletter, also recommends companies that maintain low or no debt. They will best be able to handle financial pressures when business conditions flounder. She points to 16 “royal blue chip” companies with no debt whatsoever. They are American Home Products, Betz Laboratories, A. T. Cross, Dreyfus Corp., Dun & Bradstreet, International Flavors & Fragrances, Jefferson Pilot, Lance Inc., Longs Drug Stores, Marion Laboratories, McGraw-Hill, Noxell Corp., Tambrands, Thomas Industries, Weis Markets and Wm. Wrigley Jr.

If mutual funds are your bag, there are a number of funds with proven track records of performing well in downturns. Sheldon Jacobs, editor and publisher of No-Load Fund Investor, a newsletter in Hastings-on-Hudson, N.Y., recommends Wellesley Income (800-662-7447); Lindner Dividend (314-727-5305); Mutual Shares (800-448-3863); Nicholas Fund (414-272-6133); Neuberger & Berman Partners (800-367-0770), and Mathers (800-962-3863).

Once a recession has bottomed, however, be prepared to invest in stock groups with a history of price appreciation in such periods. Groups showing the best performance coming off recession lows include companies in manufactured housing, leisure time, pollution control, savings and loans, and hotel and motel operators, a survey by Standard & Poor’s contends. Each of those groups has risen on average more than 50% in the six months from the recession lows of the S&P; 500-stock index, says Arnold Kaufman, editor of Standard & Poor’s Outlook newsletter.

- Shift some bonds into higher-quality issues. When the economy goes to hell, investors usually flee to quality. That boosts prices of the safest issues, such as Treasury securities, relative to the less safe, such as high-yield “junk bonds.”

Such was the case in the days immediately following the October, 1987, stock market crash, when recession fears sparked price rises in Treasury securities but declines in junk bonds. Investors reasoned that junk bonds could default in much larger numbers in a downturn as companies that issue them suffer declines in profits and revenues. A resurgence of recession fears recently led prices of many junk issues to decline by as much as 5%.

Does that mean you should junk your junk? Not necessarily. No one knows for sure what the default rate might be in a recession, since the relatively new junk bond market has yet to weather a full-blown one, and no one knows how long or severe the downturn will be. The default rate could be only 5% or it could be far higher than 10%, up from about 2% now, according to most experts. If the default rate isn’t too high, the higher yields of a diversified portfolio of junk bonds will continue to offset any losses from defaults.

The key is not to have all of your money in junk. And make sure you invest in junk bond mutual funds, not individual issues, because the diversification of a fund will help you weather defaults in individual issues.

- Prepare to go long. Usually a few months into a recession, interest rates decline. When that happens, the best investments may be longer-term bonds, such as 10- to 30-year Treasury issues or mutual funds that invest in them. They will gain in value as interest rates decline because people will pay more for investments offering higher rates than can be obtained on new investments. And you can lock in their higher yields.

Bill Sing welcomes readers’ comments and suggestions for columns but regrets that he cannot respond individually to letters. Write to Bill Sing, Personal Finance, Los Angeles Times, Times Mirror Square, Los Angeles, Calif. 90053.