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Recession proof your investments like Warren Buffett


We've had a couple rocky weeks here in the market with increased political tensions. It's hard for investors not to feel nervous with the number of headlines suggesting a major recession is right around the corner.  Whenever we see this level of market noise the number of calls from clients asking whether they should get out of the market increases. It's no wonder clients feel nervous. With that said, if you have a proper plan in place and have built a disciplined portfolio of quality companies, all will be fine.  

Here's Why

In the short term, recessions bring with them fluctuations and your investments are going to come down in value.  If you're someone who is drawing income from your portfolio, this is obviously a problem.  Drawing from a portfolio that is significantly down in value during retirement can be the ultimate portfolio killer.  In these cases, proper financial planning work is the key.  Here's an article that discusses some of the planning work that can be done if this is you: Tips to reduce portfolio fluctuations

For those who don't rely on their portfolio for income, and won't for at least the next 5 years, it's helpful to remember these three concepts. Good businesses live longer than recessions If you own good stocks, you own real profitable businesses.  This means you have a real ownership over a portion of that business' profits for as long as you own that business.  According to data from Ben Carlson, in his article The Upside of a Recession, since World War II the average recession has lasted 11 months, with the longest being 18 months.  

Owing a profitable business over 5-10+ years will undoubtedly put money into your pocket regardless of a recession, as good businesses have much longer lifespans compared to recessions. In October 2008, (the worst month of the financial crisis) Warren Buffett famously wrote: "To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now."

I haven't spoken to Mr. Buffett personally, but I'd be willing to bet he'd echo the same advice during today's market turmoil, however bad it gets. Don't underestimate the influence of market psychology It's important to keep in mind the influence investor psychology has on the overall market.  The number you see moving up and down on statements when fluctuations are occurring is the market value of your portfolio.  This is what the markets (the buyers and sellers) think is the appropriate price for the investments you own. Over long periods of time market prices of your investments will average out to what is likely the true value of the businesses you own, which is ultimately determined by a business's ability to generate profits.  

But in the short term, the market value is more like a voting machine, collecting the consensus of what people investing at that time are thinking the market or company is worth.  Most people are emotional. This includes investment professionals with large amounts of money at stake (you might even argue more emotional). These emotions cause investors to be overly optimistic in good times and overly pessimistic during the bad. Sometimes the market will see levels of pessimism that creates a self-perpetuating cycle that feeds off itself until the market craters.  The market during these times doesn't care how solid your company is or how profitable the businesses you own may be.  When this is occurring, it takes the market value of businesses, both good AND bad, lower.

Outperformance in Bad Markets is More Important than Outperformance in Good Markets

Today people scrutinize Buffett for lagging the overall market the last several years. They also laughed back in the 90s during the dot com bubble where Buffet lagged significantly.  If you look over longer periods of time, it's not even close.  $10,000 invested in Berkshire Hathaway (Buffet's company) in 1987 would be more than $80,000 today.  The same investment in US Markets measured by the S&P 500 index would have been worth $17,000 (80% less).

The answer lies where most don't care to look, in his performance during markets that coincide with a recession. Berkshire Hathaway, Warren Buffet's conglomerate of highly profitable well-run businesses fell 28% during the dot com bubble, not necessarily what most would call recession proof.  The S&P 500 however fell 45%, so relative to the average, that's pretty darn good. In the last three bear markets (20% drop or more) Buffett outperformed the market by significant amounts.

The title of the article suggests that Warren Buffett is recession proof.  This ultimately depends on what you mean by "recession proof."  When the next recession arrives, there will undoubtedly be over dramatic news headlines, (they get clicks).  For stock investors there will be nowhere to hide just like the previous crashes.  Buffets portfolio will drop and yours will too.  We can't time it, but we don't have to. "Recession proofing" is less about timing and more about remaining disciplined with your investments and having a proper plan in place for when these types of events occur.  

Keeping these three concepts in mind, you'll be better equipped to ride out the next recession and ultimately "recession proof" your portfolio just like Mr. Buffett. I'll leave you with the words Warren left in his October 2008 letter with the intent that you can remember them if markets and their sentiment turn against you: "Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a 'flu' epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497."

- Brandt Butt, Investment Advisor

Brandt Butt is an Investment Advisor at award winning firm Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.

This information has been prepared by Brandt Butt who is an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.


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