You Can Make Money During the Next Recession. Here’s How.

You Can Make Money During the Next Recession. Here’s How. Bart Sadowski /

Don't plan to "buy and hold" when warning signs start flashing. Here's how you can protect your downside by limiting your upside, and other countercyclical strategies.

Every day, the bull market that began in 2009 runs further into record territory. It’s either 107 months or 112-plus months old, depending on whether or not the market winds up surpassing the late-January peak in the Dow Jones Industrial Average and S&P 500 indices any time soon.

No other bull market since 1900 has ever gone on for such a long time, except for the dot-com boom (if you discount the brief tumult of 1998). This run has produced gains in excess of 300% for both indices, making it also the second-strongest bull market of the postwar era, again behind the gains of the dot-com era.

Death, Taxes and Market Adjustments

There are some arguments against an imminent market crash, but they become less and less persuasive the longer we go without one.

There are only a few certainties in life, and beyond death and taxes, the inevitable reversal of market cycles is another one you can count on. Like death, it can be unpredictable, but there’s no escaping the reality that economies cannot expand forever without correction. Nine years on, we’re almost certainly much closer to the end of an expansion cycle than we are to its beginning.

What’s an investor to do to guard against a crash in the value of their investment portfolio?

Follow the data

The first thing to do is to admit that you can’t time the market, and to reach a point where you feel more comfortable holding liquidity than assets. If the market is freaking you out right now, and you simply don’t think it’s worth holding stocks, or peer-to-peer loans, or cryptocurrencies — or whatever it is you own that can be easily liquidated and isn’t producing a must-have amount of income — it’s time to consider selling them off in careful and considered ways.

You might believe that the market is already way too heated, but you might also think it’s got room to run for another year. Whatever you believe, you should make sure you’ve arrived at your conclusions after studying the data on market cycles, economic indicators, and anything else you feel might be indicative of an impending crash. I wrote a comprehensive series of articles on bull markets, bear markets, and secular market cycles for The Motley Fool a few years ago, and they can provide you with a good amount of data on these market phenomena to get you started in your research.

Don’t decide to sell off based on gut instinct alone. There might be bulls and bears (“animal spirits”) loose in the market, but they ultimately obey data above all else.

Once you’ve reached a favorable cash position, you might want to consider deploying that cash on bearish bets against further market gains.

Shorting the Market

Short positions are one of the most common countercyclical investing strategies, particularly against index-based ETFs or against the high-PE stocks of companies that depend on strong economies for growth. Speculative stocks of all stripes are prime targets for short bets in a downturn. Even world-class companies like Microsoft and Wal-Mart tend to see their share prices decline when the market crashes, but their drops are less severe, which makes them less likely to provide you the returns you’re after on a short. Many investors seek out the safety of these blue-chip stocks during recessions, which further cushions them from the sort of declines you’d want to see from a short position. That won’t necessarily provide a positive return, so you should be careful before deciding to go long blue chip stocks in a crash.

Biotech, regular tech, smaller oil and gas companies with unproven assets, and unprofitable consumer brands are all prime targets for shorts on the eve of a downturn. You think Tesla has trouble getting profitable now? Wait until people start losing their jobs and can’t afford the monthly payments on those shiny new Model 3s. You can also short ETFs based on the more speculative sectors of the economy, like the Russell 2000 small-cap index.

Volatility ETF’s, Treasuries and Gold  

You can also buy volatility ETFs, which have been absolutely ruinous to investors over the past few years after producing phenomenal returns in the 2007-2009 downturn. Volatility spikes during a crash, but in ordinary times a volatility-tracking investment withstands enormous long-term downward pressure.

The only good times to go long on volatility are those times when chaos seems inevitable. Some volatility ETFs are leveraged two or three times, which means that they’ll provide multiple times the return on an especially turbulent day, but they’ll also wreck you much faster when things calm down. Volatility investing is a short-term solution at best, and a risky one at that.

There are other, safer options. Treasuries, typically viewed as safe-haven investments, can provide a steady payout while blue-chip companies are cutting dividends left and right. Other defensive investments, like CDs, offer similar downside protection.

Gold is a more speculative option for bearish investors, although its performance hasn’t been as reliable a countercyclical indicator as some of these other suggestions. Gold prices peaked at the start of 2012, but if you’d stayed in gold from the start of 2007 through the end of 2015 instead of rotating back into stocks, you would’ve lost out on big opportunities at the start of the bull market. The continued growth in gold prices well into the early market recovery, from 2009 to 2012, might have lulled many countercyclical investors into bearish complacency, even though most of the gains in gold came between the start of 2007 and the end of 2009.

The Bottom Line

Risk and reward are closely related in finance – which means that to limit risk, you have to be willing to limit your rewards. It is possible to make money in a downturn with safe investments like bonds – but because downturns are impossible to time, you will likely sacrifice gains before the crash.

In a recession, simply staying even often counts as a win when investments all around you are suffering a bloodbath. If you can’t identify good countercyclical opportunities, simply holding onto cash and stable bonds is still a better option than riding your stocks and other cyclical investments down into the ground. “Buy and hold” might not be dead, but it never looks particularly healthy when a crash comes.

Alex Planes

Alex Planes is a seasoned writer with over 3,000 published articles on money and personal finance. His work has been featured or syndicated by The Motley Fool, Business Insider, Fox Business, and USA Today, among others.