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High-risk investments to avoid in 2022
May 9, 2023
Verified by
Jack Stick
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In 2022, the Standard & Poor's 500 index recorded its worst start in 50 years. Although the index has recently recovered from 52-week lows, the economy is increasingly threatened by recession. Meanwhile, the Federal Reserve has shown that it will go to great lengths to keep inflation in check, which, according to many market observers, means the economy is almost certainly headed for the abyss.
The country's central bank has been quick to raise interest rates, putting a strain on the overheating economy. Investors are assessing the situation and trying to position themselves, which has led to a flurry in stocks and bonds. However, while short-term rates have risen, the benchmark 10-year bond has not touched its highs as investors begin to think about a recession.
The 5 riskiest investments of the moment
How can investors protect their portfolios until the end of 2022? One of the main ways is to avoid the riskiest investments, those that might not emerge unscathed from a recession.
1. Cryptocurrencies
Cryptocurrencies are a type of digital currency that has been attracting investors' interest for about five years. However, it is one of the riskiest investments, as it is generally not backed by assets or cash flows from an underlying entity. Cryptocurrency traders therefore try to stay ahead of others by choosing the most promising digital token.
Legendary investor Warren Buffett has come out strongly against cryptocurrencies. At his company Berkshire Hathaway's annual meeting in April 2022, Buffett said, "I don't know whether cryptocurrencies will go up or down next year, or five or 10 years from now. But what I'm pretty sure of is that they don't produce anything..... Assets, to have value, have to provide something to someone.
In the end, the only thing that sustains cryptocurrencies is investor sentiment, which can run out at any time. In August 2022, bitcoin and ethereum were already more than 60 percent below their all-time highs.
2. Consumer discretionary securities
Unlike Buffett's perennial favorite consumer goods, where products are purchased almost regardless of economic trends, the performance of consumer discretionary companies can be more volatile. Consumer discretionary companies are often much more dependent on the overall health of the economy than commodities, which means that demand for discretionary products fluctuates more during economic downturns.
While some discretionary activities may have relatively stable sales, most others fluctuate much more. For example, hotels, restaurants and leisure are popular sectors when the economy is growing, but sales drop rapidly when times get tougher and consumers reduce spending.
Therefore, if the economy slows down, consumer discretionary goods may be a sector to avoid in 2022.
3. High-yield bonds
High-yield bonds, once known as "junk bonds," vary widely in quality. Debt can be issued by excellent companies or by frankly mediocre companies. Therefore, if you invest in individual bonds, you must examine each company to determine whether it is of quality or not.
When the economy goes into recession, investors demand a higher potential return from the worst-performing companies and thus lower their bond prices to compensate. Although high-yield bonds are generally expected to fall in a recession, many of the worst-performing bonds will remain down.
If you buy an ETF or mutual fund, it is best to avoid high-yield bond funds. Although diversification can probably protect you from some of the hardest hits, it will not protect you from the general downturn that can hit high-yield bonds when investors are spooked.
4. Stocks of highly leveraged companies.
Highly leveraged companies can be dangerous investments at any time. But in a downturn they can be deadly. These companies spent the boom period accumulating debt or not paying it off. In an economic downturn, companies are often hit by declining sales, which can make it even more difficult to pay off debts. Moreover, all these debts prevent companies from taking the desperate measures they may need to survive.
The most fragile and indebted firms are likely doomed, and rightly so. Some will fail, but those that emerge on the other side of the crisis can produce spectacular returns because investors decide that the company is not ready to die. The title then changes from "doomed company" to "company at a steep discount to its competitors," but this change is at your own risk!
5. Cyclical industrial companies
Like consumer discretionary companies, cyclical industrial companies can also be affected by boom and bust cycles in the economy. When times are good, it seems like they can't get any better. And when times are bad, it seems they cannot get worse. Their stocks reflect this duality, with rapid appreciation in good times and an equally rapid decline in bad times.
What is particularly tricky about cyclical industrial companies is that they can appear to be the cheapest at the very time when it is most dangerous to invest in them. Based on valuation measures such as price-to-earnings (P/E) ratios, they seduce investors with the siren song of low multiples (seven to ten times earnings) when they are near their peak. However, when they are at their lows, during or after a recession, they appear very expensive, trading at multiples of 40 or 50 times earnings, assuming they are generating profits.
That said, if you know what you are doing, you can make a killing when the market turns after a recession.
Conclusion
Investing in individual stocks is a difficult game to win because it requires a lot of time and energy. You can do as well or better by following Warren Buffett's classic advice. The Oracle of Omaha has long advised investors to buy and hold an index fund based on the S&P 500 index, which has an annual return of about 10 percent for long periods. Although it, too, may decline in an economic downturn, this fund has a diversified portfolio of the best U.S. companies, which means it is likely to rise again as soon as the economy recovers.
Editorial Disclaimer: All investors are advised to conduct independent research on investment strategies before making an investment decision. In addition, investors are cautioned that past performance of investment products does not guarantee future price appreciation.
