Using an economic downturn to your advantage

By Max Richardson

Simply muttering the word ‘recession’ to anyone in 2022 seems to set off alarm bells. Perhaps 2008 has somewhat tarnished the idea of what a recession actually is. By definition, it is a period of economic decline in which there are 2 or more quarters of consecutive decreases in GDP. So, in theory, a 0.5% GDP fall for 6 months is as much of a recession as the global financial crisis of the late 2000’s.

However, although it appears we are entering the stage of economic decline, it is not quite in the same, sudden, lose-the-house-banks-collapse-make-a-movie-about-it-7-years-later way as the last one. I could be wrong, but the warning signs are there - the Consumer Prices Index rose by over 6% in the year to February 2022 and is only increasing, and the S&P 500 is down 16.40% YTD (as of 16 May).

Now, without wanting this to become the bleakest newsletter piece to date, I should probably explain why I have mentioned all of the above.

A recession might sound scary and can be brutal to those who don’t see it coming, but if anticipated, it can be something of a gold-mine. To steal a quote from John F. Kennedy, “When written in Chinese, the word ‘crisis’ is composed of two characters. One represents danger and the other represents opportunity.” Recessions can create golden opportunities for those who know where to look and none know this game better than Warren Buffett.

For those who don’t know who Warren Buffett is, he has been the Chairman & CEO of Berkshire Hathaway since 1970 and has, along with Vice-Chairman Charlie Munger, built an empire with a $685 Billion market cap. Highlights of their portfolio include 5.8% of Apple, 9.2% of Coca Cola, 26.6% of Kraft Heinz and 20.1% of American Express, as well as the entire ownership of Dairy Queen, Fruit of the Loom and Duracell, to name a few.

While these big names are the headliners of the portfolio and earn Buffett billions of dollars every year just in dividends, one part of his investing that goes unappreciated is that done during crises. This has earned Berkshire Hathaway huge sums on a number of occasions. In 2008 he bought $5 billion in Goldman Sachs shares under an agreed 10% dividend, with an option to buy back at a fixed price, in 2011, Goldman’s exercised this option and Buffett earned a net $500 million dollars instantly (not including dividends). In that same year he bought 10% of Chinese EV Automaker BYD for $232 million, he still owns these shares at an estimated value of $6.8 billion. What he did here falls under the term ‘value investing’, which can be simplified to buying stocks under their intrinsic value.

Buffett is doing this on an industrial scale but the principles he is using can be applied across the board. A recession and a downturn in the stock market in turn can create opportunities within the market. By using metrics like those set out by Columbia University professor Tano Santos, it is possible to identify solid companies that are fundamentally undervalued within the market. The key to making this work is having the guts to spend when others are selling, and importantly, having enough liquid assets (cash) to buy these stocks. Buffett currently holds over $140 Billion in cash which he is not investing, almost certainly waiting for further stock market issues. It might not be for a while yet, or it could be next week, but you can bet that during the next recession, Buffett will be spending, and if the most successful investor of all time is, why shouldn’t you?