US Recession Already Started? Beware ‘Defensive’ Stocks

Economic weakness is already global and very likely to be measured as recessionary in backward-looking assessments months hence. Falling revenues globally are intensifying a cash crunch and drawing capital flows out of emerging markets and currencies and into the most liquid assets such as treasuries and US cash. This is typical during global downturns, and especially when the world is encumbered with high levels of U$ denominated debt, as it is today.

For Canadians, an allocation in investment portfolios to the US dollar can be a rare place to make a capital gain on currency when other risk assets are falling. A practical caveat, however, is that it’s still prudent to keep the bulk of our savings in the currency in which we pay the bulk of our expenses. If most of our expenses are in loonies, then it is defensive to keep the majority of our funds in Canadian denominated assets even when the currency is weakening as against the greenback.

Another point to keep in mind is that once bear markets begin, all risk assets–commodities, corporate bonds and equities–dividend paying and not–tend to fall in value together. Suggesting that one hold consumer staples, or pipelines, utilities or financials as ‘defensive’ sectors, is code for saying that ‘defensive’ sectors or companies still go down in bear markets but any dividends received (3 or 4%) will help to lessen the overall loss incurred (ie., -25% capital loss -4% dividend received is a 21% loss rather than 25%).

While this may sound good in theory, in reality, dividends are woefully insufficient compensation for the losses and trauma experienced. This is particularly so, when people are withdrawing dividends received as income and so there is no reinvestment of them into cheaper shares as prices fall. It is very little understood that the historic compound returns widely quoted for equities, all assume that dividends are not spent on fees or withdrawals but perpetually reinvested into more shares every quarter. In reality, this is almost never the case, and certainly not once people are taking regular income withdrawals. This is one of the reasons that most people dramatically underperform historic returns advertised in equity marketing materials.

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