It's Not An Apocalypse, But In Case It Is...

by: Roger Nusbaum

On Sunday I stumbled across a couple of articles which each pointed to how to invest into an economic apocalypse. This is an interesting exercise in terms of how to use volatility in constructing a portfolio. Before jumping into this let me say that economic apocalypse is not my base case. For many years I have thought that this decade there will be less growth in the US than people have been accustomed to, necessitating more exposure to select foreign markets, ex-Western Europe and ex-Japan.

One article highlighted five stocks that per the title can survive an apocalypse, while the other made a case for going heavy on dividend paying stocks at the expense of bonds. The first article was simply bad (which is why I'm not linking to it) and the second article seemed to recommend a strategy that I don't think is right for anyone expecting a "great deleveraging."

To the first article, one of the stock picks was a heavy cyclical stock from the industrial sector that I am very fond of, although we don't own the name currently. If we are to take the title literally about surviving, then yes the company and its stock will survive. But if we have an economic apocalypse then the stock will get crushed and, contrary to the author's assertion, the 2% yield won't matter. If you really think there will be an apocalypse, then you don't want to own volatile industrial stocks (see below).

To the second article, it seems like we have had some measure of deleveraging already. If there is more to come (I think the author was implying it would be worse from here), then we have something of a litmus test about how to invest into this deleveraging, and it seems to me that treasuries and sovereigns from select other countries are exactly what you want to own. Lower quality paper seems likely to take it on the chin. In the last two years JNK is down 4% on a price basis while TLT is up 27% and ZROZ is up 47%. YTD the respective returns are down 8%, up 28% and up 54%. The numbers for TLT and ZROZ trounce the numbers for SPY and SDY (proxies for equities and dividend paying equities respectively). And of course there have been and will be some stocks that do indeed thrive somehow in an apocalypse.

While I continue to believe buying TLT, ZROZ or individual US treasuries is buying high, I think it is reasonable to conclude that treasuries will continue to go up if the deleveraging worsens and causes or contributes to an apocalypse. Inflation is bad for bonds, deflation is not so bad (for the right type of bonds).

In building a portfolio for the apocalypse, the first thing I would not do is completely ignore an asset class. What if there is no apocalypse? It might make sense to be very underweight equities versus a target weighting. If 60-65% is normal then maybe 25-35% for the person worried about an economic apocalypse makes more sense. In the equity portion it also makes sense to increase the yield versus the benchmark index and take a defensive tilt or own countries that you think might carry on, even if there is a US economic apocalypse.

In enhancing yield, yes there would be some DZ stocks but there should always be some. It would also make sense to have a little exposure to industrial stocks like the one mentioned above, not as a way to ride out the apocalypse but in case there is no apocalypse.

In terms of countries, perhaps a small exposure to some place like Mongolia (Market Vectors should have a fund out soon) and maybe countries known for yield and low volatility.

In terms of fixed income I'll repeat that some treasury exposure makes sense if there is a dire outcome. I would also want to own foreign sovereigns from certain countries and this has become easier to do as WisdomTree came out with AUNZ and PIMCO came out with AUD and CAD. I think there will be more of these ETFs to come.

I think preferred stocks could be owned in moderation, and it's all the better if you can find ones outside the financial sector. These often have yields in the sixes and while a financial preferred might cut in half in an apocalypse, a preferred from a non-financial probably will not.

The Barron's article about finding yield from a couple of weeks ago talked a lot about closed end funds. I would suggest going very small and find one that tends not to get pulverized during a crisis; many do but some do not. We have one of these that we are favorably disposed to in this light but there are several that exist.

There can also be room for some sort of product that has a high yield but again, go small. The context could be a BDC, an infrastructure trust, floating rate fund, mortgage REIT, an MLP or the like but I would keep these on a short leash. Personally, we are not going to own a BDC or a mortgage REIT but I may be overly conservative on this point and this does not mean that you should not explore these spaces and decide for yourself.

Keep in mind that although I grouped these as an 'other' category, they are essentially equities and, to be clear, I would not own one of each. Maybe I'd own one name from two categories at most. These things are unlikely to blow up, but it is in the realm of possibility.