Building A Recession-Proof Retirement Portfolio With 13 Stocks And Bonds (2024)

(Source: Imgflip)

Historical Volatility + Pandemic/Economic Uncertainty Have Market In A Panic

To say that we're facing high economic/corporate earnings uncertainty right now is an understatement.

(Source: Wikipedia)

In just the past nine days we've seen three of the worst days for the S&P 500 in history. As I write this, the market is down 7.6% and experiencing the 20^th worst day in market history.

The so-called "fear index" closed at a new record high on March 16, 82.7, surpassing the 80.9 record set in 2008. Technically this was the highest closing volatility ever recorded.

It's actually not the highest volatility in history, which occurred in 1987 when the stock market fell 20.5% in a single day.

While the VIX -- or the stock market's "fear gauge" -- wasn't officially launched until 1993, reverse engineering by the Chicago Board Options Exchange (CBOE) shows us just how panicked the stock market was on Black Monday. The CBOE S&P 100 Volatility Index (VXO), which basically uses the pre-2003 VIX volatility calculations and has price history going back to 1986, rose 313% to an all-time closing high of 150.19." - Schaeffer Investment Research (Emphasis added)

But let's not quibble about VIX records, and just agree that right now there are a lot of valid reasons for investors to be concerned about the short term.

For one thing, the COVID-19 pandemic continues to show no signs of slowing down yet.

Beginning on March 9^th, Italy, soon followed by France and Spain (plus smaller countries like Slovakia), began locking down their economies.

non-essential businesses (like banks, grocery stores, gas stations and pharmacies) are closed.
public gatherings of certain sizes are banned
citizens are being told to "shelter in place" and avoid leaving their homes unless necessary

This, combined with widespread testing, China first, and South Korea second, has helped get a handle on the outbreaks in those countries.

(Source: World of Meters)

However, the cost of beating this virus is going to be very steep, at least in terms of short-term economic growth.

Here's Morgan Stanley's (MS) latest economic forecast, which is rather pessimistic but their economists' views based on the best available current data.

China is projected to bear the brunt of the economic contraction in the first quarter before the rest of the world absorbs the second-quarter hit, Morgan Stanley said. The economists expect the country's economy to shrink by 5% in the first quarter before rebounding to expansion through 2020, while the US economy could contract by 4% in the second quarter.

The eurozone will face the biggest drop, with full-year growth slipping to -5%, the economists added." - Business Insider (emphasis added)

And Morgan Stanley isn't even the most pessimistic economic forecast I've found so far.

UCLA issued the revision after incorporating more recent economic data and reviewing the economic effects of the 1957-1958 H2N2 epidemic, according to a press release. After starting the year strong, "escalating impacts of the coronavirus pandemic" have dragged first-quarter gross domestic product growth to 0.4% and second-quarter expansion to -6.5%, the Anderson School of Management said.

Third-quarter growth will slip to -1.9%, and fourth-quarter growth will reach 4% with "the resumption of normal activity," the economists added." - Market Insider (emphasis added)

The good news is that UCLA's economic model, based on the best available high-frequency economic reports, says that a terrible Q2 (worst economic decline than the 5.1% GDP hit seen in 2008) will be followed by a 4.6% improvement in Q3 and very strong 4% growth in Q4.

The bad news? No amount of fiscal or monetary stimulus is going to avert the significant economic contraction that is the price every nation must pay to beat the coronavirus.

$1+ trillion stimulus bill proposed
Second coronavirus relief bill could be passed this week
Federal Reserve has cut rates to zero, begun $700+ billion QE program
Fed has also reopened the overnight credit window, acting as a lender of last resort for 1-3 month loans to corporations
Fed has pledged $5 trillion in total over the next month to keep the overnight lending (repo) market stable

This echoes the sentiment of the overall consensus among the 16 most accurate economists tracked by MarketWatch.

(Source: MarketWatch)

I'm monitoring all the latest economic forecasts from Goldman Sachs (GS), JPMorgan (JPM), Bank of America (BAC), Morgan Stanley, and any other reputable source I can find.

(Source: Imgflip)

I'm a realist whose long-term optimism about the US and global economy (and thus stocks in general) is based on the best available evidence.

But, as Chuck Carnevale recently told Dividend Kings members in a great article, it's also important to be pragmatic and realistic about the short term.

After all, there is still a lot we don't know about;

how long this pandemic will last
how long and severe short-term economic will be
how badly corporate profits will be hurt
how low stocks will fall, or how long it will take to get there

For example, while certain countries do have the virus contained relatively well, the New York Times just reported on a 100-page Federal pandemic plan that

A federal government plan to combat the coronavirus warned policymakers last week that a pandemic “will last 18 months or longer” and could include “multiple waves,” resulting in widespread shortages that would strain consumers and the nation’s health care system.

The 100-page plan, dated Friday, the same day President Trump declared a national emergency, laid out a grim prognosis for the spread of the virus and outlined a response that would activate agencies across the government and potentially employ special presidential powers to mobilize the private sector." - NYT

I've read the report and want to point the following intro to the assumptions section.

How To Build A SWAN Retirement Portfolio During These Uncertain Times- And Profit From The Inevitable End Of The Crisis

The larger the market decline, the bigger the returns in the future. Here's the historical data going back to 1950.

The Bigger The Decline The Higher The Future Returns

(Source: Michael Batnick)

Here's the modern era data, going back to 1990, showing forward returns over various time periods, based on market volatility at the time.

As you can see, the more frightening the market, the richer the returns, across all time frames.

And with the VIX currently at 75, now seems like a better time to buy stocks than almost any other. As Baron Rothschild once said:

"The time to buy is when there’s blood in the streets."

And with the blood flowing, will you heed the baron’s advice?

Of course, losses may counting to mount for months (or longer). Of course, this time might be different.

But, even if the market relationships that have held up for the last three decades prove useless, then what? If you have cash to buy stocks now and you won’t buy, when will you? What’s your plan?

If you are afraid of losing money, then why are you even considering stocks at all?"- Nick Maggiulli (emphasis original)

Now I know a lot of you might be very frightened right now, expecting the market could keep falling like this for months, maybe even years.

So here's Ritholtz Wealth Management's CEO Joshua Brown offering historical context, from someone with decades of experience in the asset management industry, and what he's telling his firm's clients.

I am going to share with you something I said to the clients of our firm last week. I think it’s the most profound thing I have ever learned about crisis in the investment markets.

That something is this:

Without a doubt, the news will get worse from here. But its ability to shock us will diminish.

The economic news about the US economy was not getting better at the end of the financial crisis. But stocks stopped going down every time that bad news hit. It took a lot of pain to get to that point, but eventually, bad news fatigue had set in. This happened with regard to potential terror threats in the wake of 2001. It happened during the Asian currency crisis of 1998. It happened during the Latin American defaults of the same era. It happened during the Ebola scare of 2014. It will happen now.

You must be fully prepared for both foreboding news about the contagion’s spread and, yes, even the death rate. You must also be prepared for how bad the March economic numbers are going to be relative to February. Some of these comps are going to be so astounding that they’ll look like typos. And it’s highly doubtful that anything turns sharply higher in April, based on the fact that nearly everything under the sun has been or will be canceled other than walking the dog and surfing the web. Kroger, Costco, Amazon, Target, CVS, Walgreens, Walmart and maybe Home Depot excepted – the nesting business is booming.

But as bad as the news will be, its ability to shock us will diminish. We will reach the point of “Let me guess, sales are down this month.” The shocks – and there are many shocks still to come – will continue. But our reaction to them cannot remain at the current intensity forever. We are not going to have a 75 Vix for six straight months.

If we know one thing for sure, it is this." - Joshua Brown (emphasis added)

But in a vacuum of hard data and rampant speculation and rumors, people are desperate for certainty, of any kind.

So here's Michael Batnick, a leading asset manager at Ritholtz (where the four best financial bloggers on Wall Street work) to provide his guess about how bad this could become.

As far as the markets go, I don’t think the S&P 500 low of 2367.04 is going to hold. I’d put the odds of new lows at 60%. My best guess is we get a ~10% rally and roll over, ultimately falling 40% from peak-to-trough. I don’t believe this with very much conviction, let’s go with 10%, and I do not plan on acting on my intuition...

So here is what I plan on doing.

I will continue to make regular automatic contributions into my 401 K and into my taxable account. Both are fully invested in the stock market. If stocks fall 40% from their peak, so another 18% from here, then I plan on taking money out of my emergency reserve and moving it into the market. If they fall 50%, or another 17% from where I bought, then I will buy more. If they keep falling, then I’ll have bigger things to worry about than my portfolio.

I encourage you to write down your thoughts and put together some sort of plan if you haven’t already.

If you’re on the brink right now, imagine how you’ll feel if stocks fall another 20%. I hope we never get there, but investors have to be prepared for anything at this point, because right now, nothing feels obvious, and hindsight is 2020." - Michael Batnick

Okay, so the best and brightest on Wall Street are not panicking, and continue to follow the long-term plans they've outlined for their clients (and themselves).

But in today's market, where preservation of capital seems far more important than returns on capital, how is someone looking to construct a bunker retirement portfolio to proceed?

13 Stocks & Bonds That Can Build A Bunker Portfolio During This Bear Market

My motto is quality first, valuation second, and prudent risk management always. The goal is to have your hard-earned savings invested in such a way as to minimize the probability of a permanent loss of capital.

Because while true that investing new money into a high fear environment is normally profitable, that's over the long term. But as you can see, in the short to medium term stocks can do anything, based on what's affecting corporate fundamentals at the time.

A great retirement portfolio requires fundamentally strong companies, but also a portfolio that allows you to sleep well at night or SWAN during times when even the staunchest buy-and-hold investors can lose faith that stocks will ever go up again.

This brings us to the first step in building a bunker retirement portfolio: supreme quality.

Not just in good economic times, but especially periods when the credit markets are tightening.

In recent weeks, we've seen a sharp increase in correlations between all assets.

(Source: Nick Maggiulli)

Here's Nick Maggiulli, a Data Scientist for Ritholtz Wealth Management, explaining what these rising correlations might mean.

Not 100% sure since we don’t have much data to go on, but it suggests that investors are cashing out entirely. They are forgoing bonds (the traditional safe haven) and moving to cash.

This is why everything seems correlated now. Individual stocks are moving with their stock indices like never before, risky assets are moving together, and even bond assets are now starting to selloff as well.

I don’t have enough data to prove this definitively, but, in the coming weeks, we will be able to determine whether investors are cashing out en masse. Like most things nowadays, we will just have to wait and see what the data tells us...

Maybe some of these investors own a business that is being negatively impacted by coronavirus (i.e. travel, hospitality, etc.) and they are cashing out to cover expenses or lost revenue. Others might be cashing out to hedge against expected job loss or some other adverse outcome.

Unfortunately, the best answer I can give you is: I don’t know." - Nick Maggiulli, (emphasis original)

There is indeed some reason for concern about credit markets tightening.

(Source: YCharts)

According to S&P, about 50% of corporate American bonds are BBB rated. Here is a chart of the difference between 10-year Treasury yields and average BBB bond yields, the so-called risk premium or spread.

During the Financial Crisis, this risk spread hit 7.7% and credit markets were so tight that even sound businesses had trouble obtaining new loans or refinancing old bonds.

Bond credit ratings are a proxy for quality and represent estimated 30-year default risk.

(Source: S&P)

As you can see, BBB ratings mean about 7.6% 30-year default risk, and credit rating agencies do their best to model multiple economic cycles in their ratings.

Or to put another way, some of the sharpest risk-managers in the world are baking in exactly the kind of risks we're facing today into their ratings.

(Source: Ploutos) data as of March 16

You can see above that the higher the credit rating, the better the returns have been this year. Note that even AAA-rated JNJ and MSFT are not immune from the decline, but are merely down a lot less.

This makes sense given the tightening credit conditions resulting from so many institutions rushing to secure cash to cover credit line drawdowns (big banks), or cover margin calls (like hedge funds of CEF/ETFs).

The 10 Best Low-Volatility Blue Chips To Help You Sleep Well At Night

I recently highlighted some very low volatility, objectively high-quality blue chips, including many Super SWANs and dividend aristocrats. For that screen, I eliminated anything without an A- or better credit rating.

For this article, let's up the quality factor even more by

selecting only companies with A credit ratings or better
10/11 SWAN quality ratings (not 9/11 blue chips)
5/5 dividend safety ratings
20+ year dividend growth streaks (Graham's standard for superior quality)

As always, I begin by eliminating anything on the Dividend King's Master list of 420 companies that is trading above fair value.

331 companies are at fair value or better
Companies at fair value or better with A credit ratings: 79
+ 10/11 SWAN quality or better: 48
+ 5/5 dividend safety: 43
+ 20 or more year dividend growth streaks (includes the Great Recession and Tech Crash): 19

Fundamental Stats On These 19 Companies (Just quality and safety metrics)

average quality score: 10.7/11 SWAN vs. 9.7 average aristocrat and 7.0 S&P 500 average
average dividend safety score: 5.0/5 vs. 4.7 average aristocrat and 3.0 S&P 500 average
average dividend growth streak: 36.3 years = dividend aristocrat
average return on capital (Greenblatt's proxy for quality): 76% =87th industry percentile = very high quality
average 13-year median ROC: 86% (stable quality/moat)
average 5-year ROC trend: +5% CAGR (improving quality/moat)
average credit rating: AA (1% 30-year bond default risk, very high quality/strong balance sheet)
average annual volatility: 21.5% vs. 22% aristocrat average and 26% Master List average
average market cap: $204 billion = mega-cap

These are relatively low volatility SWAN stocks, with AA credit ratings and objectively some of the highest quality companies on earth. They are giants with access to a sea of low-cost capital that should withstand even the harshest of credit market conditions in the coming years.

But our goal here is to construct a retirement portfolio, which means that we need to think of sector diversification.

These are the risk management guidelines I use in running all my portfolios, including my retirement portfolio.

So let's look at how much industry diversification we have.

2 energy (11%)
1 finance (5%)
5 tech (26%)
3 industrial (16%)
5 healthcare (26%)
3 consumer staples (16%)
1 consumer discretionary (5%)

Goldman is the most pessimistic. The investment bank said last week we could see Brent fall as low as $20 a barrel if the oil price war between Russia and Saudi Arabia continues long enough...

"The prognosis for the oil market is even more dire than in November 2014, when such a price war last started, as it comes to a head with the significant collapse in oil demand due to the coronavirus."- Oilprice.com

Given that the outlook for energy is rather bleak for the next 12 to 24 months, let's eliminate XOM and CVX, which are likely to get a downgrade below our 10/11 SWAN minimum threshold in the next week (when I update all oil & gas companies on the Master list).

Remember that sector diversification is important and with energy gone we're down to 6/11 sectors. Since this is a long-term portfolio I feel we should have at least one of each remaining sector.

But since tech, industrials and finance can be highly volatile at times, what I'll do next with this portfolio is sort the companies by annual volatility and choose the lowest volatility one from each except for defensive sectors.

This is how we arrive at just 12 names, which represent the core of a solid long-term retirement portfolio.

(JNJ): arguably the safest dividend stock in the world, with AAA credit rating
Pepsi (PEP): consumer staple dividend king with 14.3% annual volatility over the last 15 years
Colgate (CL): AA-rated consumer staples dividend king with 15% annual volatility
Kimberly-Clark (KMB): A-rated dividend aristocrat with 15% annual volatility and recession-resistant business model
Automatic Data Processing (ADP): AA-rated dividend aristocrat with just 18% annual volatility (incredibly low for a tech stock)
Roche (OTCQX:RHHBY): AA-rated dividend champion healthcare giant
Berkshire Hathaway (BRK.B) (BRK.A): AA-rated financial juggernaut with over $120 billion in cash reserves
TJX Companies (TJX): A+ rated consumer discretionary with a 23-year dividend growth streak
Medtronic (MDT): A-rated dividend aristocrat healthcare giant
Stryker (SYK): A-rated dividend champion healthcare giant
Canadian National Railway (CNI): A-rated industrial with a relatively low historical volatility of 22.6%
Novo Nordisk (NVO): AA-rated healthcare giant with 22-year dividend growth streak

Fundamental Stats On These 12 Companies

average quality: 10.8/11 SWAN quality vs. 9.7 average dividend aristocrat and 7.0 average S&P 500 company
average dividend safety: 5/5 very safe = 4.7 average aristocrat and 3.0 S&P 500 average
average yield: 2.4% vs. 2.5% S&P 500 and 2.6% most dividend growth ETFs
average valuation: 15% undervalued
average dividend growth streak: 38.1 years = dividend aristocrat
average 5-year dividend growth rate: 9.8% CAGR
average analyst long-term growth consensus: 7.6% CAGR vs. 6.3% S&P since 2000
average forward P/E ratio: 16.4
average PEG ratio: 2.14
average return on capital: 70% = 89th industry percentile (very high-quality by Greenblatt's definition)
average 13-year median ROC: 84% (relative stable moats/quality)
average 5-year ROC trend: +1% CAGR (improving moats/quality)
average credit rating: AA- (fortress balance sheets, very high-quality)
average annual volatility: 19% vs. 15% S&P 500, 26% Master List Average, 22% average aristocrat
average market cap: $139 billion
average 5-year total return potential: 2.4% yield + 7.6% growth +3.4% CAGR valuation boost = 13.4% CAGR (10% to 17% CAGR with 25% margin of error)

But remember, I said we're trying to build a retirement portfolio, which means a balanced portfolio that includes the proper allocation of stocks/cash and bonds.

This is what keeps you from having to sell stocks in a bear market when even the highest quality companies on earth can trade at ridiculous prices.

We're also facing tightening credit conditions with some cash equivalents that use corporate bonds (instead of pure US T-bills) seeing much higher than normal declines.

(Source: YCharts)

In fact, as you can see recently, even bonds have recently stopped acting defensively. Whether or not that's due to a global liquidity crunch we don't yet know.

The only thing that remains a non-correlated asset is Treasury bills.

Why do I point this out? Because of the very reason that so many commenters say that no one should potentially be in the market right now.

we don't know how bad the recession will be
we don't know when the market will bottom.
bonds are no longer acting defensively

So how would I take the very risks we now face and turn them to our advantage?

(Source: Portfolio Visualizer)

By putting 50% of funds into cash via BIL, and then equally weighting all the other companies.

Would I recommend staying 50% cash forever? No, I'd use the 10% to 20% of that cash to steadily buy more of these 12 companies should the market fall further.

But what if you are a very conservative investor and just stuck with 50% cash forever? Here's how this portfolio would have performed since January 2008, with annual rebalancing. That means it's been through a 57% market crash during the Great Recession, precisely the thing that so many fear is coming yet again.

This backtest actually begins near the market's all-time high in October 2007. Or to put another way, it answers the question

"What if you invested your money at a market peak and before stocks crashed."

Bunker Retirement Portfolio Since January 2008 (Annual Rebalancing)

(Source: Portfolio Visualizer)

What's remarkable about these collections of 12 world-class companies and BIL, is that even if you spent the entire 12-year period 50% in cash, you would still have earned good returns. Not as much as a 60/40 stock/bond portfolio, but you would have suffered half the peak decline of just 16% during the Great Recession.

The reward/risk ratio is 50% better than a balanced portfolio and annual volatility was just 6%.

(Source: Portfolio Visualizer)

Notice how BIL is the only negatively correlated asset in this retirement portfolio. Everything else has relatively low beta, but during a bear market correlations tend to go to 1.

This is why standard deviation is the better volatility metric. This portfolio's standard deviation was 6%, vs. 9% a 60/40 standard balanced portfolio and 15% for the S&P 500.

Or to put another way, it was almost three times less volatile than the broader market but still generated decent returns for very conservative retirees.

What about these 12 stocks on their own? Without any cash to serve as ballast/store of value for living expenses/dry powder?

(Source: Portfolio Visualizer)

While most of these companies have standard deviations (volatility) higher than the S&P 500 on their own, combining them together yields a 100% equity portfolio that was 21% less volatile than the broader market over the past 12 years.

In other words, the power of diversification is that your volatility, even without cash or bonds to act as a hedge during downturns, is reduced compared to any individual company.

My point is that, even in the scariest market in recent memory, you can always find reasonable and prudent ways to put savings to work.

Bottom Line: When Facing High Uncertainty, A Focus On Quality, Valuation And Strong Risk Management Is Best

I know it feels like the world might be ending, given how the market is acting right now. We've now had 7 consecutive 4+% daily swings, in either direction, which is a new record.

But as hard as it is to believe, the world is not actually ending, and while a recession now appears likely, today really is the best time in 12 years to put new discretionary savings to work.

Discretionary savings = money you will not need for at least 3-5 years

With the bond market temporarily no longer serving as a good hedge, I consider t-bills, such as BIL to be a fine source of ballast/store of value/dry powder right now.

Combine the wealth preserving power of a large cash holding (50% in this case) with the proven long-term income and wealth compounding power of A-rated blue chips such as JNJ, PEP, CL, KMB, ADP, RHHBY, BRK.B, TJX, MDT, SYK, CNI, and NVO, and you truly have a recession-resistant bunker portfolio.

How do I know? Because this retirement portfolio has been through this almost exact situation before.

it did relatively well from January 2008 to March 2009, falling a peak of 16%, 41% less than the S&P 500 and 15% less than a 60/40 balanced portfolio.

Whether your risk profile is one that requires a 50% cash allocation to let you sleep well at night, or you simply want to be able to greedily add to these top-quality SWAN stocks during this historical bear market, this portfolio of 13 stocks and bonds represents a diversified and prudently risk-managed choice in these frightening and uncertain times.

----------------------------------------------------------------------------------------Dividend Kings helps you determine the best safe dividend stocks to buy via our Master List. Membership also includes

Access to our four model portfolios
30 exclusive articles per month
Our upcoming weekly podcast
20% discount to F.A.S.T. Graphs
real-time chatroom support
two exclusive preferred stock portfolios
exclusive updates to David Fish's (now run by Justin Law) Dividend Champion list
exclusive weekly updates to all my retirement portfolio trades
Our "Learn How To Invest Better" Library

Click here for a two-week free trial so we can help you achieve better long-term total returns and your financial dreams.