Planning For The Next Recession

While I definitely do not have a crystal ball, I do believe that we are nearing our next recession, and with it our next bear-market in stocks.

The most compelling evidence I see for a recession in the next 2 years is the persistent inverted yield curve. Even if the Federal Reserve decides to cut rates in the near term, the past has shown the predictive power of this signal, even after it has corrected itself.

What About Not Trying to Time The Market?

There have been plenty of studies showing that people on average are pretty terrible at market timing. The vast majority would have been better off just leaving their investment un-touched, the studies say.

If that is the mentality you plan to follow, you’d just better be sure that you follow it. If you use that mentality to keep you in stocks at these highs, you’d better also believe it enough to prevent you from selling your stock if the market falls 10, 20, 50 percent.

Dollar Cost Averaging

If you are going to try to buy low and sell high, one of the smartest ways to do so is hedging against yourself through something called dollar cost averaging.

Essentially this means instead of buying or selling everything all at once, you do so over an extended period of time, reducing your risk of poor timing. I am incorporating this strategy into my investment plan for the next 2 years, but more on that later.

Where Could The Market Go?

While an inverted yield curve has successfully predicted the last 7 recessions, it has taken between 3 and 24 months for the recession to actually show up.

It has been 3 months since the initial inversion of the yield curve, leaving plenty of time for the market to go higher. I actually expect some sort of strong rally to end the bull market and am targeting a peak price of somewhere between 3350 and 3500 on the S&P 500.

Based on those price targets and the historical track record of the yield curve suggesting that the latest we could see the next recession would be around April of 2021 I want to dramatically reduce my stock exposure over the next 21 months.

My Plan

To keep with the spirit of this blog I want you all to be privy to my plan and how I am attempting to navigate the next few years of investing.

For the longest time about 90-95% of my liquid net worth has been invested in stock. Over the last 3 months I have made some changes to lay the groundwork for the coming two years.

First I opened a SoFi Money checking account (read all about those here) where I have been building up cash reserves that are yielding 2.25% (2% as of the latest rate cut), and second I shifted some of my equity investment into fixed income assets including one CD (Certificate of Deposit) and an allocation to a bond index fund in my 401(k).

So now, 3 months into the inversion, I have shifted to a portfolio that is 80% stocks, 20% Cash/Bonds.

Future Time-line

I probably won’t take my equity exposure all the way down to zero, but I ultimately would like to get it into the 10-20% range before the recession hits.

Every 3 months from the initial inversion I am going to aim to reduce my equity exposure, unless the market hits my price target before that, at which point I may make a dramatic reduction in exposure earlier on.

Allocation Targets

October 2019 (~6 months from inversion): 75% Stocks, 25% Cash/Bonds

January 2020: 60% Stocks, 40% Cash/Bonds

April 2020: 50% Stocks, 45% Cash/Bonds, 5% Put Options

October 2020: 30% Stocks, 55% Cash/Bonds, 15% Put Options

January 2021: 15% Stocks, 55% Cash/Bonds, 30% Put Options

Building Cash and Going Short

I’ll discuss options in a future post, but essentially put options are a convenient way for me to short the market. In other words, my plan ultimately aims to not only preserve the bulk of my capital from destruction in an upcoming recession, but also to make money on the drop in stock prices.

If/when the stock market drops, I would not only make money on that drop, but should have a ton of money on the sidelines in cash ready to take advantage of the low stock prices, setting myself up for great returns in the next bull market.

Taking Risk While You’re Young

We’ve all heard it. If you’re going to take investment risks, it is best to do so when you are young and have your whole life to make the money back if you lose it.

While I’d like to think everything in this post is well thought out, this plan, and trying to “time the market” is my big risk, and has the potential to either drastically speed up or slow down my millionaire timeline.

Thanks for reading. Click here to subscribe and never miss another update. Leave a comment below to let me know how you are preparing for the next recession.