With predictions that we could be facing the longest recession since records began, we take a look at whether it can be a good idea to invest during a recession.
If the moves by the central banks to raise interest rates fail to reduce inflation, it is looking highly likely that higher interest rates could further weaken economic growth.
However…
Successful businessperson, Warren Buffett, once said that it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.” It may be sensible to take a contrarian view on stock markets: when others are greedy, they may continue to pay a large price tag to buy a share or asset. When confidence is high, people continue to invest and don’t think about downsides. When others are fearful, it may present a good value investment opportunity. You buy more for your money when prices are low! This doesn’t mean to say that values may not continue to fall for a period of time, but it does mean that over the longer term you may derive good value from buying low.
The impact on investments
Generally, recessions mean lower stock market prices, therefore higher levels of volatility than normal. The price of a stock should represent the current value of a company’s future cash flows and cash flows are created by the earning of a company. If there is lower spending in an economy, then this means lower earnings for businesses. This may also result in lower dividend distribution from the company to shareholders.
If perceived earnings are lower, then a company’s share price is also going to drop. With the increased chances of a business struggling or worst case, going bust due to the challenges faced in a recession, the markets also consider this as a risk in share prices.
Not all stocks are the same
Different stocks will go up or down more than others in certain economic conditions. Stocks which are more sensitive to the overall health of the economy are often referred to as cyclical stocks and are those which will suffer from a reduction in consumer spending or unemployment rates rising e.g. retailers and airlines, with people spending and travelling less.
On the flip side, are those who provide something which consumers consider essential, such as utilities and food. These are often referred to as defensive companies or defensive shares and would generally fare better and fall less. Albeit, utilities have seen more volatility than usual due to an unusual set of circumstances.
Diversification
It is key that investors ensure they have a portfolio capable of withstanding an economic recession rather than trying to time the market. This means including assets which are likely to do well during economic growth, but also some that are likely to do better during a recession – this is known as diversification! Although it is essential to carefully consider the risk profile, it is usually good to include a broad mix of equities, bonds, and some alternatives. It may also be a good idea to consider a variety of sectors and themes too.
One rule that is often viewed as a simple way of achieving diversification, is the 60/40 rule. This means having 60% invested in shares and 40% in other diversifying assets and is seen as a sensible theory for trying to smooth out any peaks and troughs of investing in the stock market.
Bonds
One of the most common assets that usually perform better during a recession, is government bonds. There are a number of reasons why bonds typically do better and are generally seen as safer than stocks. Governments of advanced economies tend not to default and the income produced by a bond is fixed, this means that during a recession, investors often rush into bonds which in turn can bid up their prices.
However, it has not been a good year for bonds so far with rising inflation and higher interest rates causing bond prices to plunge. This has resulted in bonds and shares falling together and having a negative impact on those portfolios working to the 60/40 strategy.
The outlook of bonds therefore rests largely on inflation and how inflation is likely to be impacted by a recession.
How can we help?
As always, every individual situation is different, and it is vital to get advice based on your exact circumstances when considering any type of investment. PM+M’s Managed Portfolio Service, is a bespoke investment portfolio produced by us, and managed in collaboration with AJ Bell, to make your life easier.
Working together, we continually monitor the market and conduct ongoing due diligence in relation to the funds held within the Managed Portfolio Service portfolio. We proactively make fund and asset allocation changes when we feel as though this is necessary in order to manage volatility and drive long term growth. Our Managed Portfolio Service aims to provide you with the best combination of investments to maximise your potential returns with a level of risk that suits you.
If you would like to discuss your investments in more detail, or need some tailored advice specific to your situation, including more information on our Managed Portfolio Service, get in touch by emailing financialplanning@pmm.co.uk, or by calling 01254 679131.
The value of investments can fall as well as rise. You may not get back what you invest.
The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction.