3 Ways to Prepare for the Coming Recession

Source: Thinkstock

Source: Thinkstock

Investors essentially shrugged off yesterday’s news that first quarter GDP came in at negative 2.9 percent. But that doesn’t mean you should too. The economy is weak, and with the Federal Reserve tapering and with geopolitical tensions heating up, you need to think about eliminating risk from your portfolio.

In particular you need to consider selling, or even going short those companies that are highly correlated to the U. S. economy. This doesn’t simply mean that you should sell your U. S. stocks and buy inverse ETFs on U. S. stock indexes. The reason for this is two-fold. First many of these companies get a lot of their revenues overseas. For example McDonalds (NYSE:MCD) is a U. S. listed company, but it gets most of its sales overseas in Europe, Asia, and South America. Many of these economies are still growing, and McDonalds will likely not be heavily impacted by a decline in U. S. GDP. Second, many sectors of the economy will not be hit by a recession, and they may even benefit. For instance low-end retailers should do very well.

With this in mind, if you are looking to sell some of your holdings or to go short, you need to isolate those companies that are economically sensitive and that operate primarily in the United States. Here are a few ideas to consider after the jump.

Source: Thinkstock

Source: Thinkstock

1. Sell or short JC Penney (NYSE:JCP)

JC Penney is a struggling retailer that operates primarily in the United States. The company has been losing money because it implemented some poor strategies a couple of years ago. While it has seen a bounce in sales, it is still losing money rapidly, and a recession might be the final nail in the coffin.

JC Penney caters to lower and middle class consumers. These are the consumers who will get hit the hardest in a recession, and they are also likely to trade down and hunt for bargains at dollar stores or at Wal-Mart.

Given that the company is struggling already, and given that it is vulnerable to a recession, I think the shares offer an interesting opportunity from the short side. So far this year, the stock has been on a wild ride. It started the year at just over $9/share, traded down to below $5/share and then doubled, hitting a peak of over $10/share on the last earnings announcement. But investors quickly realized that this announcement wasn’t so good, and the stock has melted back down to $8.50/share. Investors looking to get short should do so above $9/share.

Source: Thinkstock

Source: Thinkstock

2. Short the Russell 2000 Index (NYSEARCA:IWM)

The Russell 2000 is comprised of 2000 small-cap companies that trade in the United States. Smaller companies tend to be more domestic and so your risk of getting exposure to a strong international economy is reduced. Furthermore, the Russell 2000 trades at a very high valuation of nearly 30 times earnings, as investors tend to flock towards small cap stocks when they are optimistic. Also, several small caps simply don’t have any earnings.

The iShares Russell 2000 ETF reached a high in March of just over $120/share and after trading down about 10 percent it has risen back up to $117/share. It appears to be topping out again and it looks like it could roll over. Investors who want to short the Russell 2000 can either directly short this fund or they can buy an ETF that shorts the Russell 2000. There are a couple of these depending on how much leverage you want. If you want a fund that tracks the daily inverse performance of the Russell 2000, consider the Proshares Short Russell 2000 ETF (RWM). You can also opt for 2-X leverage Proshares Ultrashort Russell 2000 ETF (TWM) although this is a riskier fund. Keep in mind that these are trading vehicles and that they stop correlating inversely to the Russell 2000 over an extended period of time.

Source: Thinkstock

Source: Thinkstock

3. Buy Dollar Tree (NASDAQ:DLTR)

Dollar Tree  is the fastest growing of the dollar store companies yet it trades at just 19 times earnings—a lower multiple than the S&P 500. If we see a recession in the U. S. then American consumers are going to trade down and dollar stores will be the beneficiaries. Dollar Tree has been extremely well run and it is growing as more American consumers are forced to take low paying jobs or live off of meagre government benefits. While this is bad for these Americans and for many American companies a company such as Dollar Tree stands to benefit. The stock currently has a lot of support at around $50/share vs. today’s share price of $54/share.

Disclosure: Ben Kramer-Miller holds no position in the stocks and ETFs mentioned in this article.

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