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What is the best way to prepare your portfolio for a recession ahead? Investors can’t avoid this question much longer.

The Royal Bank of Canada, the Conference Board of Canada and the International Monetary Fund have all warned that a downturn is coming over the next year or so. No, a recession is not an absolute certainty, but it is such an overwhelming probability – 70 per cent, according to the Conference Board – that it should be the basis for any realistic investing plan.

A good place to begin your own recession preparation is by looking at where experts think safety might lie. You won’t find much unanimity here – none at all, in fact – but, by understanding the strengths and weaknesses of different approaches, you can gain a better appreciation of where sweet spots may exist in today’s market. Here are three strategies to ponder.

Load up on dividends: Many Canadian brokers and strategists are urging investors to focus on solid dividend-paying stocks as a bulwark against market uncertainty.

The logic here is simple. Dividend-paying stocks can keep pumping steady streams of cash into your pocket even during an economic downturn. To the degree the companies can raise dividends, these investments can also offer some protection against inflation.

Better yet, dividend stocks have historically beaten the market in Canada. If past is prologue, there is good reason to think they will continue to perform well over the long term.

But how about the short term? This may be the only weak point in the case for Canadian dividend investing.

Dividend stocks aren’t immune to downturns. When the stock market swoons, they do too. The past couple of decades show that Canadian dividend stocks tumble pretty much in line with the overall Canadian stock market during rocky patches.

The real advantage of dividend investing during a downturn is that the steady dividend income gives you an excellent reason to hang on to your stocks rather than selling in a fit of panic. But steady dividends don’t protect you from falling share prices. If the market slides further in months to come, expect dividend stocks to share in the pain.

Buy bonds: Yes, yes, I know. Your bond portfolio has suffered a hellacious shellacking in recent months. Many smart investors, though, see that as an opportunity to buy into the asset class on the cheap.

Kunal Mehta, a U.K.-based fixed-income strategist at asset manager Vanguard, made that case during a visit to Toronto this week. He argued that rising interest rates and deteriorating economies are clouding the outlook for stocks over the next year or so.

In contrast, bonds – especially investment-grade corporate bonds – are offering a solid, secure payout. Their prices have been beaten down so far that they now offer yields that look positively lush compared to alternatives such as GICs.

Bonds have other advantages, too. They are liquid – unlike a GIC, you can easily sell them before maturity. They also offer the potential for capital gains. Since bond prices move in the opposite direction of interest rates, any plunge in inflation and in interest rates over the next year or two has the potential to send their value soaring.

This all sounds tempting. But, as with dividend stocks, there are complications.

The biggest concern for bond investors is what happens if inflation doesn’t relent over the next couple of years. If inflation turns into a persistent problem, as it was in the 1970s, bonds’ real return will be leached away by rising consumer prices.

Jared Woodard, head of the research investment committee at Bank of America, warned in a note this week that once a developed economy breaches the 5-per-cent inflation level – as Canada and the U.S. both have – it takes an average of 10 years to wrestle inflation back to 2 per cent. If that pattern repeats itself, bonds may not be such a hot deal after all.

Bet on the physical: Mr. Woodard argues that it’s not just bonds that will be hit by a shifting economy. In his note, he says getting inflation below 5 per cent will be a multi-year challenge. If so, interest rates will stay persistently high and drag down stocks across the board. He sees the S&P 500 index falling from around 3,700 now to around 3,000.

The key to getting through this downturn, he says, is dumping yesterday’s high-flying speculative winners, like technology stocks, as well as government bonds (at least until yields hit 5 per cent). Focus instead, he says, on “value, physical sectors” – energy producers, power generators, food merchants. These are profitable sectors that investors have largely shunned in recent years.

Sounds reasonable, doesn’t it? The danger, though, is that Mr. Woodard’s pessimism on inflation may be misplaced. Maybe prices will plunge over the next year, as many economists predict. Maybe we will quickly go back to a world that looks much as it did pre-pandemic. If so, loading up on the market’s stodgiest sectors may not work out so well.

Bottom line: You can make plausible cases for many different strategies. The reality is that nobody knows for sure what is going to work best over the next year.

One consolation is that if you were to lump together all the expert recommendations outlined above, you would arrive at an energy-heavy, dividend-focused portfolio with a hefty weighting of bonds – something that looks an awful lot like a standard plain-vanilla Canadian balanced fund.

If that is where your money is right now, your best move to prepare for a recession ahead might be simply to sit tight. Shocking, isn’t it? But comforting.

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