In a recession, there are few safe ports for investors

Q: Assuming we're headed into a recession, what can we expect from the markets, and will markets outside of the U.S. follow suit?

A: The R word is at the top of many investors' minds. I'm not going to sugarcoat this: If the economy dips into recession, it won't be a happy time for your portfolio.

Certainly, some areas of the market hold up better than others during an economic downturn. Investors may seek safety by buying bonds, shares of utility companies and makers of consumer staples such as deodorant and toothpaste. These investments tend to outperform less mature industries, like technology, and more risky investments, such as shares of small companies, during economic slowdowns.

But let me be clear: During a severe economic slowdown, almost all investors get hurt. Let's go back to the 2000 to 2002 bear market. The broad Standard & Poor's 500 index had negative returns of 9.1%, 11.9% and 22.1% in 2000, 2001 and 2002 respectively. That cumulative loss is brutal, considering that the S&P 500 is a diversified portfolio of large-company stocks.

Large companies in growth mode, namely technology, suffered the biggest declines in that bear market. The Russell 1000 Growth index, which tracks companies in this category, lost 22.4%, 20.4% and 27.8% of its value in 2000, 2001 and 2002. Interestingly, large value-priced stocks, measured by the Russell 1000 Value index, held up better and gained 7.0% in 2000 before falling 5.6% in 2001 and 15.5% in 2002.

What about foreign stocks? They did offer some protection, but not as much as you might think. Value-priced international stocks, for instance, gained 4% in 2000, according to index provider MSCI. They fell, though, by 15.4% in 2001 and 14% in 2002. And even emerging markets stocks had a tough time, falling 30.6% in 2000, 2.4% in 2001 and 6% in 2002.

Investors need to remember that bear markets do not follow a script. For instance, shares of small companies wound up being a relative safe spot during the last bear market. The Russell 2000 index, a benchmark for small-company shares, fell 3.0% in 2000, gained 2.5% in 2001 and lost 20.5% in 2002.

The bottom line? During a recession, there are no dependable safe havens other than short-term bonds and Treasuries. And even these have risk. But recessions and bear markets are a fact of life. Even before a recession hits, craft your portfolio in such a way that you can live with it in good times or bad. That way, you'll have the courage to hang on when things get scary and be invested when the recession finally ends and stocks shoot up again.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.

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