Investing in a Recession
The US economy and world economy are likely already in a recession. A recession is defined as two quarters in a row of negative GDP growth.
Goldman Sachs estimates Q1 2020 GDP will shrink by 6% while Q2 2020 US GDP will drop by 24% due to decreased business and consumer spending driven by social distancing. The St. Louis Federal Reserve is equally bearish over the next few quarters.
So it appears that the longest economic expansion in the U.S. history has come to a close.
And appropriately the market is down.
As of this morning, the Dow Jones is down 38%. The S&P 500 is down 35%.
In times like these, we need to heed the advice of Warren Buffett.
“Simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
Counterintuitively, when market volatility is high, risk is low because investors are expecting the worst.
Recent research by Verdad found that historically speaking, returns tend to be exceptional following significant market pullbacks.
If you were to buy small cap value stocks, small cap growth stocks, large cap value stocks, or large cap growth stocks – in other words, almost all stocks – 3 months after a 20% drop in the S&P 500, you would have generated returns of 41%, 34%, 23% and 24%, respectively, over the subsequent 12 months on average.
Here’s a summary chart:
If you bought the market, history suggests you would do pretty well.
But you don’t have to buy “the market.”
You can pick your spots.
I’m not a big fan of large caps (I usually find much better opportunities in small/micro caps), but Altria Group looks dirt cheap selling at 7.7x free cash flow and a dividend yield of 10%. Altria grew revenue and its dividend through the Great Financial Crisis. Smokers aren’t going to stop smoking because of covid-19 (unfortunately). If Altria eventually re-rates to its typical 5% yield, the stock has 100% upside.
Facebook is selling at 22x earnings versus its 3 year median PE of 32x and 5 year median of 35x. In 2019, FB grew revenue 27%. I don’t see it slowing down any time soon.
MSG is selling at a market cap of $4.6BN. For that market cap, you get Knicks which Forbes estimates are worth $4.6BN, the Rangers (worth an estimated $1.6BN), the Madison Square Garden arena (worth ~$1BN), $1.1BN of cash and an entire live entertainment company which will be spun off later this year.
Are live sports and shows impacted by Covid-19? Definitely. But will people want to return to see live shows and sports after the epidemic fades. I think so. Does MSG have the balance sheet to ride out the recession? Definitely.
In summary, stay calm and continue to buy high quality companies. If you have cash, start to put it to work.