Every economic cycle eventually ends. And when it does, how you’ve positioned your portfolio makes all the difference.
Think retiring early with that sports car you’ve always wanted versus working for so long that you start wondering if you’ll need to keep a cane at the office. Personally, I’m not worried about a severe recession anytime soon. The data isn’t there. But I’m humble enough to understand that few get the timing perfect.
And that means we need to prepare… not predict. After all, it’s better to have a plan and not need it than vice versa.
In today’s edition of the Wide Moat Daily, I’m focusing on an underappreciated part of the economy. When capital dries up during uncertain times, it profits with near certainty. I’ll explain exactly how. And don’t worry, they do plenty well during good times, too.
An Even Stronger Moat
While most industries struggle to hold on to clients during tough times, economic cycles reinforce the moats of companies that provide capital. It might flow like a river during booms, but capital is rationed during downturns. It becomes precious, selective, and most important of all, expensive. And the firms that can provide it when everybody needs it can do very, very well.
I’m not talking about the whole banking industry. Far from it. A regional bank with billions of loans tied to overpriced used cars and low-quality borrowers is terrified of a bad recession, and they should be.
When a recession hits, people struggle to repay those loans. If it gets bad enough, they stop altogether. “Jingle mail” was common during the mortgage crisis. People would stop paying the mortgage and just mailed the keys back to the bank. The envelope “jingled” when you picked it up.
So, no, I’m not talking about the banks.
I’m talking about a much more sophisticated part of the economy. Companies that quality businesses depend on for debt and equity.
Think exchanges, private lenders, and investors with deep pockets. Their services multiply in value when the credit markets tighten. Terms improve in their favor overnight. And one year of hyperactivity sets up a decade of potential outperformance.
Probably the most famous example is Warren Buffett’s decision to buy $5 billion of preferred shares in Goldman Sachs (GS) during the dark days of 2008. Those preferred shares paid a 10% dividend, and Buffett got warrants as a “kicker.” And while not as publicized, there were other firms that stepped up during 2008 that got similar deals.
Don’t get me wrong. The stock price of firms that step into this void are likely to suffer temporarily in a market crash. But that’s a good thing for intelligent investors. It allows us to allocate at great valuations ourselves. Then the companies do the heavy lifting from there, sourcing and closing deals.
I’ll talk about two specific areas and a few companies you can keep on your radar.
In Case of Emergency, Look Here
The first are top-tier Wall Street asset managers that specialize in taking advantage of downturns. Ares Management (ARES) is a great example. They have some of the most skilled distressed debt experts in the world.
For instance, when regional banks ran into trouble in 2023, Ares stepped in. It bought up a $3.5 billion portfolio of loans from PacWest, a California regional bank. Our High-Yield Advisor service – which holds many companies like Ares – saw 20%-plus returns that year.
Another category is business development companies (“BDCs”). To be clear, you must do your due diligence as some BDCs will be losers in a bad downturn. That’s why we only select the best for my High-Yield Advisor service, which currently owns several investment-grade BDCs with yields above 10%. Blackstone Secured Lending (BXSL) is a solid option that we booked over a 30% total return on recently.
I managed money at a hedge fund throughout the Great Recession. One of the traders’ favorite sayings was millions are made in bull markets, but billions are made in bear markets. That’s because things move faster and fear creates more opportunities than greed. We all remember those missed opportunities during 2008/2009 and early 2020.
Having a game plan for when – not if – a bad recession arrives is the secret weapon.
And that’s for both your portfolio and mental sanity. Now, you have a couple concrete areas that have historically profited from downturns.
Regards,
Stephen Hester
Chief Analyst, Wide Moat Research
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