How to Invest During a Recession
What is a sensible investing strategy during a recession? We share insights on what to look for and what to avoid during an economic downturn.
Written by Victoria Kent, Senior Investment Specialist
This information does not take into account your personal objectives, financial situation or needs. You should consider if the relevant investment is appropriate having regard to your own objectives, financial situation and needs.
One of the world's biggest banks recently warned the struggle to stem inflation will spark a global recession.
Deutsche Bank's grim prediction is: when the US recession hits, the stock market will plunge 25 percent from today’s levels, but then will recover fully by year-end 2023, assuming the recession lasts only several quarters.
Of course, these guys don't have a crystal ball, but even the World Trade Organisation (WTO) agrees a recession is on the horizon for some markets:
"It may not happen everywhere, but several key countries risk sliding into recession," said WTO Director-General Ngozi Okonjo-Iweala at the most recent G20 leaders meeting in Indonesia.
Economists here in Australia are divided over the severity of a potential downturn. But already the poor performance of Australian equities and bonds has placed both asset classes on track to record a calendar year loss.
You would be forgiven for having whiplash - it wasn't that long ago Australia and other global markets were experiencing a bull run. As CNN colourfully puts it "Between 2020 and 2022, stocks shot toward the moon. This year, they’ve been jettisoned back to Earth.”
This poses the question: what is a sensible investing strategy during a recession?
To answer that, we go back to basics.
What is a recession?
Recession comes from the Latin word recessus, meaning "a going back, retreat." It is the economic way of describing a reversal in growth. Unsurprisingly, it is officially defined as two successive quarters of negative growth.
Recessions are not uncommon. In fact, it is well known that the economy (and markets) moves in cycles, fluctuating between periods of expansion and contraction. The four cycles are expansion, peak, recession and recovery.
Sector behaviour and investment selection
Cyclical investments are known for following the cycles of an economy as they are more sensitive to changes in economic activity – you can expect those to perform poorly during a recession.
Some examples which are hit the hardest during a recession are banks, consumer discretionary stocks and builders. These sectors are likely to experience a significant decline in sales and profits. Growth sectors like technology are particularly vulnerable to rising interest rates.
Conversely, counter cyclicals (or non-cyclical) investments do not follow the typical flow of the economic cycles, and tend to do well during times of a recession. The so-called "defensive stocks", include utilities, telecommunications, insurance and healthcare. These sectors have historically proven to be more resilient, as consumers continue to buy through all economic cycles.
So, if we know a recession is coming, what should we invest in?
During a recession, most investors would be wise to avoid highly leveraged companies with huge debt loads on their balance sheet. It is more prudent to invest in companies with high quality earnings, strong balance sheets, low debt and good cash flow.
As we wrote about in a recent article Bulls, Bears and Stags: It's a zoo out there, one way to possibly mitigate the effects of downturn is through diversification. Diversification can come in your choice of sectors (international versus Aussie, developed markets vs emerging, resources vs technology) as well as in asset classes (fixed income, property, equities, alternatives).
But finding enough good assets to have a diversified portfolio is bloody hard. And all the stock picking brains combined with all the luck in the world can't make miracles happen.
Sometimes it's not about making money, it's about not losing money.
Remember, there is no rule that you have to be active in the markets. Sometimes it pays to wait and see, think long-term horizons and invest through the cycle.
Too often, investors can exit the market at their lows, and then have to buy back in once markets have begun to rally again. As long as you have a high-quality portfolio and the patience to sit through an economic downturn, your patience could be rewarded.
Billionaire nonagenarian (and Warren Buffet’s business partner) Charlie Munger once famously scolded:
“If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century … you deserve the mediocre result you’re going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations.”
Try and take heart in this harsh reality assessment! Market volatility is inevitable, but over the long term, markets tend to bounce back. Try to ignore the noise and think of the big picture. Make sure you have a long-term horizon, stay rational, have confidence in your investments and stick to your plan.