The Dow Jones Industrial Average seems to be on a permanent downward track. The nation’s GDP has plunged into negative territory. And something once considered unthinkable—a depression—is now a real possibility. That’s the finding of Harvard economists Robert Barro and Jose Ursua, who studied the long-term data for stock market crashes and depressions from 25 countries, including the U.S. In a recently published paper, the economists conclude there’s a 20% chance that U.S. GDP and consumption will fall by 10% or more, something not seen since the early 1930s—in other words, a depression.
Of course, that would mean there’s an 80% chance a depression won’t happen. (I know which outcome I’ll be rooting for.) Still, for investors who want to prepare for the worst, you have options. “If you invest like it was the 1930s again, you can still make money,” says Lou Stanasolovich, CEO of Legend Financial Advisors, who shifted to a defensive strategy last fall. Stanasolovich’s moderate low-volatility portfolio, for example, invests two-thirds of its assets in hedge-style funds that counterbalance their exposure to stocks, such as Caldwell and Orkin Market Opportunity, Diamond Hill Focus Long Short and Rydex Managed Futures. Another 30% of the portfolio is stashed in high-quality fixed-income funds for additional safety. Since October this asset mix has generally delivered small but positive returns.
For nervous investors who don’t have enough assets to spread among a large number of funds, a simple alternative would be to shift a portion of your portfolio to safe accounts, such as bank CDs or money market funds. Granted, you will probably have to settle for yields of 2% or less these days. But inflation is also relatively low, so those yields actually give you decent real returns. And as Stanasolovich points out, “In times like these, where we are looking at deflation rather than inflation, even a 0% yield is a positive return.”
Still, a defensive allocation, while ideal for a Grapes of Wrath scenario, makes for a poor long-term investing strategy. You won’t get the growth you need to rebuild your nest egg. And sooner or later inflation is bound to spike again—some forecasters even worry that the ballooning government debt will eventually spark hyperinflation. If that were to happen, Stanasolovich says, your best strategy would be a heavy allocation to commodity funds and other inflation-beating assets. So if you do decide to revisit the 1930s, be prepared to shift your portfolio back to the future, or at least the 1970s.
-- Penelope Wang