How to Invest During a Financial Crisis

The US Federal Reserve lifted interest rates on Wednesday.

Normally this would be a sign of a stronger US economy.

But with such debt levels and dependence on liquidity, many argue it’s far too soon to be ripping the Band-Aid off just yet.

I shared my views with you on the subject in Friday’s Money Morning. Basically, I thought there was a low probability of the above happening.

After all, the Fed is not ripping money out of the system at breakneck speeds. Investors also don’t seem phased by interest rates at 3.4% by 2020.

But for a moment, let’s consider a crisis is imminent. In such a scenario, US stocks would likely fall…a lot. Stocks globally would be hit.

Question is, could you shelter yourself from such carnage?

Are crisis-proof stocks real?

Cash might be the first thing that comes to mind when stocks drop 20%…then 30%.

It’s not a rational impulse, judging from history. But it’s an effective way to stop the pain. Selling now prevents further losses. It also removes the constant worrying of wondering what will happen next.

If you listen to the doomsayers, we’re in for a liquidity crisis. That means cash is scarce and everybody wants it. To get your hands on some AUD you’d need to sell your assets (stocks) for drastically low prices.

So maybe a mad rush to cash isn’t the best option.

Alternatively, you could try and guess when the next crisis will hit. That way you can get out before it all comes crashing down. Very few have built a career on timing financial crises however.

OK, what if you just ride it out? No matter how low stocks go, just sit and wait…hoping for clearer skies.

If this was your plan, you’d want to make sure you remove any debt driven stocks from your portfolio. Holding companies with lots of debt never really pans out when cash is hard to get.

But if you don’t want to do any of the above, there’s one last alternative.

It involves directing your attention to industries that, historically, have done well even during crises.

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The best stocks to buy in a financial crisis

Take Ferrari NV [NYSE:RACE] as an example.

Typically, an auto manufacturer is a terrible buy heading into a crisis. Most use lots of debt, which potentially leads to bankruptcy. Industry earnings also usually decline as consumers tighten their belt.

That may be true of the broader car market. But luxury cars are a different beast altogether.

Have a think about the types of people that buy Ferraris. These are cars that can cost anywhere from $250,000 to upwards of a million dollars! But it’s not just the price tag. ‘In addition to being toys for rich and famous and extremely expensive when compared to regular cars, Ferraris exude exclusivity,’ Seeking Alpha writes.

That effectively puts Ferrari in the league of its own when it comes to the economics of the business. Ferrari management famously says that they would produce one less car than there is a demand for it.

In other words, there is a designed level of scarcity, resulting in long wait times, sometimes up to two years for some models.

There are also limited editions, such as latest LaFerrari. To buy one of these cars which retail for over a $1m, it doesn’t help that you simply have enough money to afford it because there are only 499 that they made. You would have to be on an exclusive loyalty list, built over years, and proven by continually purchasing their products over a long period of time.

As a result, Ferrari has historically reported good earnings even in times of crisis.

Another industry that tends to do well during crises is consumer staples. An example is Costco Wholesale Corporation [NASDAQ:COST]. If you’re unfamiliar with the name, Costco is like a warehouse supermarket.

Not only do they stock all kinds of food and drink, you can pick up a new set of golf clubs, the latest TV, hardware suppliers, books…the list goes on.

What’s more, all of these items are usually cheaper at Costco than anywhere else. For example, in September Costco was selling more than a kilo of pretzels for $7.99. Had you bought the equivalent at Coles or Woolies on special, you would have paid $12.24.

And discounts like these are slapped across the Costco range. The secret to Costco’s prices is their warehouse model. They only buy goods in bulk and pass on more, sometimes all of the savings, onto customers.

This is a massive point in Costco’s favour. When a crisis hits and consumers tighten their belt and Costco becomes an even more attractive place to shop.

But this isn’t even the reason Costco’s stock would do well in a crisis.

Not only does Costco operate a warehouse model, they’ve also have a membership model working for them as well. That’s right. There is a $60 annual membership fee to shop at Costco.

Because shoppers can get incredible savings at Costco, many don’t might paying the $60 fee each year. And this is really the secret sauce of Costco’s stability.

The company doesn’t make a whole lot of money selling goods. They make most of their money selling memberships. And because these are paid upfront annually, earnings are relatively stable year to year.

Even if shoppers didn’t enter a Costco because of mounting debts and lack of cash, the company would still likely make a decent amount of money, all thanks to memberships.

Of course, these are just examples of companies that have foundations in place to ride out a crisis. That’s not to say they would.

Again, no stock is crisis-proof, and these two are no exceptions.

But the rule applies: You should always consider the characteristics in any industry or stock that have the kinds of qualities that don’t damage — and perhaps even boost — the core business whatever the financial climate.

Your friend,

Harje Ronngard,
Editor, Money Morning

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Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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