Winter is coming?

On August 2, significantly worse-than-expected non-farm payroll data caused market turmoil, and expectations for the US economy quickly turned from a soft landing to a recession. The "VIX" (panic index) soared and risk aversion spilled over from the US stock market to global markets.

If a recession occurs, how should we respond? This article will explore the possible strategies.

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Cash Reserves

Although painful, recessions are an inevitable part of the economic cycle.According to Charles Schwab's statisticsSince 1948, the United States has experienced 12 recessions, an average of one every six years.

Recessions are usually accompanied by bear markets, and market declines often occur before the arrival of a recession. Although the average duration of a recession is only 11 months, the market usually takes more than two years to rebound to its pre-bear market peak.

At this time, it is important to increase cash reserves. Holding enough cash during market turmoil can prevent forced selling during a market downturn and leave room for entry when the market stabilizes and has entry value.

According to the latest documents disclosed on August 3, Berkshire Hathaway, owned by Warren Buffett, accumulated cash reserves of an unprecedented $277 billion in the second quarter of this year. After new highs in cash reserves for several quarters, explosive growth in cash reserves occurred in the last quarter, mainly due to a significant reduction in Apple stocks.

Although the reason for the operation was not publicly explained, the market believes that the "stock god" may be wagering that the US economy will enter a recession and wait for a cheaper entry opportunity.

Bonds

During the 2008 financial crisis and the COVID-19 pandemic in 2020, in order to cope with the recession, the Federal Reserve cut policy interest rates to zero. When policy interest rates begin to turn, the yield on US bonds will also decline, and bond prices will rise.

MorningStarStatistics for eight typical recession periods since 1929 show that stocks often perform poorly during recessions, while bonds record positive growth for all periods of economic weakness. In addition to the driving force of the Federal Reserve's policy shift, during periods of economic turmoil, investors often turn to safe, stable, and more liquid assets.

US bonds offer a wide range of duration choices, from as short as 1 month to as long as over 30 years. In general, longer-duration bonds are more sensitive to fluctuations in interest rates, and prices are more volatile.

Holding a single bond usually requires more effort. For ordinary investors, using ETFs can achieve a more diversified bond portfolio.

There are many bond fund products with different durations available on the market. Investors can find related products that track US bonds through Futubull's thematic ETF function. The specific route is: Market>ETF>Thematic ETF> US Treasury Bond ETF. Currently, the largest ETF that tracks US Treasury bonds is the 20+ year US Treasury bond ETF ( $iShares 20+ Year Treasury Bond ETF     (TLT.US)$ ), also the ETF product with the longest duration.

Investors who prefer to invest in single bonds can also make arrangements on Futubull by following this path: Discover > Financial Management > Bonds > US Treasury Bonds.

Inverse ETF.

During market downturns, it is also an option to hedge through inverse ETFs. However, it should be noted that inverse ETFs are complex financial instruments that do not simply track indices but use various complex strategies involving derivatives (mainly futures and swap contracts) to achieve a negative fit against the index. Such assets have higher risks and may not be suitable for most investors.

The primary issuer of inverse ETFs.Proshares.Explained the logic of the fund's operation. Traditional index funds can match the performance of benchmark indices in any period, but inverse ETFs can basically only meet the investment target or multiple of the day and need to change the portfolio position every day to re-balance their exposure to their benchmark indices.

If holding inverse ETFs for more than one day, with the passage of time, they tend to deviate from the fund's original target. Especially in the volatility of the market, it will cause losses to inverse ETFs. The higher the multiple or the greater the fluctuation of the benchmark tracked, the more pronounced the impact may be.

Assuming that the market fluctuates 5% every day for two days:

In an uptrend, the ROI of a -1x fund for two days is -9.75%; in a downtrend, the ROI of a -1x fund is 10.25% when the benchmark index falls for two consecutive days by 5%; and in a volatile market, the benchmark index falls by 0.25% within two days, and the inverse ETF also falls by 0.25%, without offsetting effect.

The cost of inverse ETFs is also higher. For example, the annual fee rate of a positive tracking of the Nasdaq 100 index is 0.2%, while the fee rates for one-way inverse, such as PSQ.US and three-times inverse SQQQ.US, are 0.95%. For investors who want to participate, it is best to carefully understand the investment objectives and operational methods of relevant products. $Invesco QQQ Trust     (QQQ.US)$ has an annual fee rate of 0.2% for positive tracking of the Nasdaq 100 index, while the fee rates for one-time inverse $ProShares Short QQQ     (PSQ.US)$ and three-times inverse $ProShares UltraPro Short QQQ ETF     (SQQQ.US)$ Although the overall performance of the stock market is poor during the recession, there are also some sectors that are relatively strong. Consumer staples, healthcare and utilities usually perform well during the recession.

Defensive sector.

Although the overall performance of the stock market is poor during the recession, there are also some sectors that are relatively strong. Consumer staples, healthcare and utilities usually perform well during the recession.

Even with the impact of economic weakness, consumers find it difficult to easily reduce their spending in these areas, making it a safe haven in recession. Real estate, information technology and energy industries, however, may be hit harder due to their sensitivity to demand fluctuations.

Related risks

The recent market expectations have been volatile, and the unexpected non-farm payrolls in July seem to have plunged the United States into a recession overnight. As a new week begins, the non-manufacturing PMI slightly exceeded expectations, giving the market a soft landing expectation once again.

The poor employment data is also affected by bad weather such as hurricanes. Although the labor market is cooling, it is not as serious as expected, and the popular "recession trade" in recent times may not appear.

Although there is no interest rate meeting in August, the Fed will hold its annual symposium in Jackson Hole on the 22nd to 24th. Fed Chairman Powell will deliver a speech to clarify his views on the economic situation and future monetary policy. At that time, investors should have a clearer understanding of the U.S. economic situation.

Risk disclosure: This content does not constitute a research report, is for reference only, and should not be used as a basis for any investment decisions. The information involved in this article is not a comprehensive description of the securities, markets, or developments mentioned. Although the information source is considered reliable, the accuracy or completeness of the above content is not guaranteed. In addition, no guarantee is given for any statements, opinions, or forecasts provided in this article.