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Home / Markets / Stock Markets /  The 4 Crises that Could Hit Your Portfolio and How to Deal with Them

The stock market is rising. The economy is on the path to recovery. Crude oil prices are falling. It’s only a matter of time before inflation comes under control.

Even Raghuram Rajan says there is no economic crisis in India.

So what’s the problem? Why are writing about potential crises?

Well, it’s not that we like being in a crisis. It’s just that it’s important to be aware of what could happen in the future.

This is so that we can be prepared for any eventuality. After all, your hard-earned money is at stake. And to be forewarned is to be forearmed.

So let’s dive into the 4 crises that could hit your portfolio…and how to deal with them.

High Inflation

For most of us, inflation is a way of life. We think of it as a crisis only if it spikes dangerously high or if it lasts for a long time.

During 2009-2014, we faced both. India had high inflation and it lasted many years. This was trying time for most people.

This time around, the view on inflation seems to be that it will go away soon. In other words, high inflation is unlikely to last beyond 2022.

The reasons are falling commodity prices including crude oil, rapidly rising interest rates, and global supply chains are slowly getting back to normal.

These are all valid points. But what if high inflation persists despite all this? What if 2022 is 2009 all over again and we have to deal with some more years of rising prices?

This is not something being talked about by experts or the media.

Why would they talk about it? No one wants to hear it.

But you can bet that the smartest investors in the world are already thinking about it. And they have made plans accordingly.

So what can you do if this situation comes to pass?

In a period of high and persistent inflation you will need to allocate your wealth into precious metals, gold and silver, as well as fundamentally high-quality, high dividend-paying stocks. These are the two best asset classes for such times.

Income-generating commercial real estate is also a good option.

What should you avoid?

Fixed income assets like bonds and fixed deposits with a lower yield than inflation.

If the fixed interest rate is below the inflation rate, these ‘assets’ are actually liabilities. They will erode your wealth during periods of high inflation.

High Interest Rates

Interest rates are going up all over the world. Rising global interest rates are seen as a good thing because it’s one of the ways to bring down inflation.

This is true. But if interest rates remain high for too long, it can hurt the economy. It will reduce borrowing and thus spending. This will reduce revenues and thus profits of corporate India over time.

Even potential prime borrowers, the ones with the best ability to repay, could delay their spending plans in this situation. This can happen in the case of individuals as well as businesses.

Companies with high debt will also suffer during this time. So will interest rate sensitive stocks.

Taken together, this will cause a slowdown in the economy. And this will be negative for the stock market.

In fact, it’s even worse the stock market. Rates on government bonds are used to estimate the value of future profits of corporate India. This is because these bonds are considered to be risk free.

Thus, higher interest rates ‘weigh down’ stock prices. Investors are unwilling to pay a high PE ratio for high growth stocks.

In this situation, it’s best to invest in high yielding fixed deposits or corporate debentures. However, avoid locking up all your funds in long term assets. Spread your fixed income investments over short term and long term tenures.

What to avoid?

Most stocks won’t perform well in this situation. You will have to find specific stocks (smallcaps) that are growing despite the tough economic conditions.

Utilities, FMCG, and pharma stocks could also hold up fine but are unlikely to be wealth creators.

Thus how to invest in the stock market is going be a challenge if interest go up significantly and remain high for a few years.

A Long Recession

By long recession, we mean a recession that may not be severe in terms of negative GDP growth but one that lasts for a few years.

Such a recession could be non-continuous, i.e. an economy could dip in and out of short mild recessions over a period of years.

This kind of recession is hard to imagine but it’s possible if multiple disruptions hit the world one after another.

In these situations three asset classes are likely to perform well – fundamentally strong stocks, government bonds, and gold.

What to avoid?

Fundamentally weak stocks will get hammered if the market factors in multiple disruptions. Some weak companies could go bankrupt. The banking sector will also be put to the test in this scenario.

Demographic Slowdown

This is something that has recently come to the attention of the world’s best investors and businessmen. And it worries them a lot.

It was assumed that population growth is not a problem to worry about as long as there is enough economic growth.

The growth would raise living standards. As people grew richer, they would have smaller families. Thus, the high population growth would slow down naturally.

But this logic is now openly being challenged by the idea of the ‘middle income trap’. This is when a country population growth slows down drastically but growth is not fast enough.

Thus while people of the country are no longer poor, they aren’t rich either. The country get stuck as in the ‘middle income trap’.

Read more about this here – Every Long-Term Investor Needs to Prepare for the Population Problem.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.

This article is syndicated from Equitymaster.com

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