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2019-11-12 15:24:57

A recession is coming… We cannot predict its exact timing, but what we know is that:

Recessions generally occur every 5-10 years.When unemployment rates hit 4-5% figures.And when the yield curve becomes inverted.

Each of these factors combined together is a powerful signal that has accurately predicted recessions in the past. Today, we are 11 years into the expansion, unemployment is below 4% for the first time since 1969, and the yield curve recently inverted.

At the same time, investors are rightfully concerned because most major asset classes appear richly priced even as we get closer and closer to the edge of the cliff:

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Recession-related articles are very popular during these times as investors seek to prepare themselves for the inevitable. Many market pundits have recently recommended to shift to cash and fixed income to lower risk.

We believe that this is very dangerous and expensive. Our plan is to remain fully invested – even as we approach the coming recession. Here is why:

The Risks of Holding Cash (And Fixed Income)

While in the near term it is safer and less volatile to hold on to cash (or equivalents); it comes at a steep cost in the long run.

One dollar in 1913 is the equivalent of over $25 dollar today. And believe it or not, that is not so bad when compared to many other countries. Consider that the German population lost all its savings two times in the past ~100 years. All the money you had worked so hard for was worth literally nothing overnight.

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But this cannot happen to the US Dollar, Euro, or any other major currency of a developed nation, right? Well, to that we would just suggest taking a look at history because there is no escaping history… Fiat currencies always eventually fail.

“Paper money eventually returns to its intrinsic value: zero” Voltaire

Today, the printing presses going wild all around the world and central banks are experimenting new untested policies. We believe that it is increasingly risky to hold non-inflation protected assets, such as cash and equivalents.

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Holding some cash as part of an overall portfolio strategy is essential; but anything else than a minor allocation is not an option for us. We worry too much about inflation risk and the opportunity cost of holding non-productive assets.

You Cannot Time the Market

No one has ever managed to time the market consistently. Warren Buffett from Berkshire (NYSE:BRK.A) (BRK.B) is arguably the world’s most successful investors and he has always remained invested in all time periods and laughed at market timers.

“We’ve long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children.”

He invests in every year, good and bad. Recessions and recoveries. Tops and bottoms. True wealth is built day by day. Not by trying to discover the unknowable.

We are strong believers in “time in the market” rather than “timing the market.” Despite what market “experts” will tell you, hopping on and off of stocks has never worked.

When the stock market bottomed in March 2009, news pundits screamed, “It’s dropping another 50%!”

At the best buying opportunity of a generation investors liquidated.

The market rose 10%.

Pundits screamed, “Sucker rally! Get out now!” And investors sold.

The market rose another 10%.

Pundits screamed, “Double dip recession coming. Get out now!” And investors sold.

We’re now ten years into one of the greatest bull markets in history. For 10 years pundits have screamed, “Get out now!” And investors have sold.

When the buying opportunity is greatest the economy and markets look the scariest. And most people freak out and sell.

When questioned why they say, “I’m waiting until it’s safe to get back in.”

So if you can accurately determine when a recession will start. How deep it will go? When it will end? And accurately determine the same thing about the stock market. Then waiting for a recession to invest is a great strategy.

One little nagging problem. No one has ever been able to do that consistently.

One other little nagging problem. In the midst of an economic hurricane most people panic. Very few have the chutzpah to buy.

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It is not only impossible, it is extremely dangerous to try jumping in and out of the market. To illustrate this point, consider that the average investor generated only 2.6% per year over the past 20 years:

During the same time frame, passive investors who held on to a REIT index fund (VNQ; IYR) earned close to 10% and the S&P500 (SPY) earned 7% per year. Market timing does not work.

If Not Cash, Then What?

Rather than materially increasing cash levels, we believe that investors should focus on remaining discipline. You do not change course from one day to another simply based on some macro-economic forecasts. If you have a solid investment strategy, you stick to it. The market will occasionally go against you, but remaining on course for the long run is absolutely crucial.

At High Yield Landlord, we heavily invest in Real Estate (mostly through REITs) because we know that time is on our side:

Buy at a 6-7% cap rate.Finance half of the purchase with a 3-4% mortgage.Appreciates at 2-3% per year (along with income growth).

And you get close to ~12% annual total returns. Then, once these property investments are structured as part of a “REIT”, investors enjoy the additional benefits of liquidity, cost-efficiency, professional management, limited liability, and passive income. Ups and downs are inevitable – but time in on the side of REIT investors.

Moreover, because REITs produce highly consistent cash flow from long term leases and they may offer valuable protection in a recession. Researchers from Cohen & Steers (CNS) note that:

REITs have outperformed the S&P 500 by more than 7% annually in late-cycle periods since 1991 and have offered meaningful downside protection in recessions, underscoring the potential value of defensive, lease-based revenues and high dividend yields in an environment of heightened uncertainty.

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This is especially true today because REITs enjoy the strongest balance ever, fundamentals remain healthy, and valuable multiple are below most other sectors.

What is my point here?

You should not go all cash.You should stick to a winning strategy.You should invest in real-asset heavy companies that offer inflation protection, resilience to recessions, and high income.

I personally hold a Real-Asset heavy portfolio because real assets (including REITs, MLPs, Infrastructure, Energy, etc…) have a lot to offer even in today’s late cycle economy:

(1) Higher income yield: The 10-year treasury may yield only 2.1%, but real assets will often trade at yields in the 6-10% range – and can be leveraged to generate even greater cash-on-cash returns.

(2) Greater total returns: Real assets generate high income, but they also appreciate in value and grow cash flow. A well-located office tower may yield 6% and grow in value by 3% per year. Add to that a bit of leverage and you can reasonably expect double-digit total returns.

(3) Inflation protection: One of the biggest and most underrated risks today is accelerating inflation. When you invest in low yielding bonds, you are at big risk. Real assets, on the other hand, are well-protected as their income and values tend to grow along with inflation. As such, they provide a good hedge against inflation risk.

(4) Valuable Diversification: Traditional assets (stocks and bonds) are highly volatile and adding real assets to a portfolio has proven to lower volatility. As such, investors can profit from diversification benefits while boosting returns and income.

With interest rates expected to remain lower for longer, we believe that these attractive attributes will continue to attract more and more capital towards real assets in the long run. Do we know where prices will be 6 months from now? No. But we do know that there is a lot of money to made over the coming decade and sticking to the game-plan is the only way to profit in the long run.

Note that REITs have outperformed all other asset classes over the past 20 years:

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Bottom Line – We are Landlords, Not Stock Market Traders

Our investment strategy is not rocket-science. We aim to buy properties at less than what they are worth in order to achieve high income and capital appreciation. That’s it. It is just common sense that such strategy, when implemented correctly, can lead to fantastic investment results.

We like to say that we invest like landlords. We want appreciation, but most importantly we want high and sustainable income. We see REITs as cash flowing real estate investments, and NOT as stocks. We are real estate owners, not “stock market traders”. We mind fundamental performance of the properties, and NOT the short-term share price performance.

“Buy a stock the way you would buy a house. Understand and like it such that you’d be content to own it in the absence of any market.”

High Yield Landlord, #1 Service for Real Estate Investors and Retirees

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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