What a recession means in the stock
To understand what a recession means for the stock market, it helps to understand exactly what a recession is.
There are a number of definitions but put most simply, it’s when there is a significant slowdown in a country’s economic activity over a period of time. Generally if there is a decline in a country’s Gross Domestic Product (GDP) for two consecutive quarters (two three-month periods) then the economy would be seen as being in recession.
The threat of a global recession is looming large because of “once-in-a-generation” factors such as the effects of the Covid pandemic and the war in Ukraine, and this has an impact on stock markets and investors across the world.
Tough times for consumers
A recession has a variety of negative effects that can be felt across society: increased unemployment as companies retrench workers; people spend less money on goods and services; companies cut down production as consumers buy fewer products and services; and wage levels come under pressure.
For the consumer, the cost of living can increase as prices of items like petrol and groceries increase. This leads to a reduction in their spending on discretionary (non-essential) items. Job losses can further affect consumers’ income levels, while it can become even harder to find employment as companies look to reduce their wage bill and cut down on new hires.
Profits under pressure
None of this is good news for the listed companies that trade on the stock market, or for those who have shares in these companies. Although the stock market is made up of individual companies that fulfil a wide variety of services and produce a variety of products, to a large degree the success of these companies is influenced by the broader economy.
If the economy is thriving, then companies (and their share prices) will tend to benefit. That means happy days for shareholders. And of course the inverse applies. If the broader economy is under pressure, or in a recession, then this will generally have a negative effect on listed companies, and their share prices.
All in all, a recession can be a scary time for investors, with wild swings in share prices, downward pressure on investments, and a distinct lack of stability and predictability.
So where does that leave you, the investor?
Take a long-term view
When you start investing, one of the most important factors to take into account is your investment timeline – in other words, how long you want to keep your money invested for. This can differ depending on what your investment goal is. For example, if you’re in your 30s and you are saving for retirement, then you’ll be investing with a long-term horizon. If you’d like to cash in your investment for a house in the next two years, then that would be considered a short-term investment horizon.
During a recession, when investments have generally reduced in value, it helps if you have a longer-term horizon and don’t rush to access your investment if you don’t need to. All markets go through cycles, and eventually a recession will run its course. Cashing in investments during a recession, or “at the bottom”, can be avoided if you are able to sit tight and stick out the downturn. Yes, it’s hard not to panic when you see the share price plummet, but panic doesn’t make for good investment decisions.
As American investment guru Warren Buffet says, “It won’t be the economy that does in the investor over a five, 10 or 20 period – in my view, it will be the investors themselves … if you look at the record of the 20th Century you’d say ‘How could anyone have missed in owing equities?’ and yet we had all kinds of people wiped out … if you had just owned stocks straight through, didn’t leverage them, you would have had perfectly decent returns.”
Ensuring you have a diversified portfolio – one that is spread between the different asset classes such as stocks, property, bonds and cash – is one of the cornerstones of sensible investing. This is because it spreads your risk so that when one asset isn’t performing, you’ll be cushioned by the performance of your other assets. During a recession, when there is an increasing amount of volatility, diversification can help protect your investments.
Invest with caution
And yes, a recession can even offer some opportunities for investors because there are likely to be some “cheap” stock buys on offer.
“While a recession can be a difficult time for investors who are seeing declining values across their portfolios, it can also represent an opportune time to pick up value stocks whose price has been adversely affected by the wider sentiment. For investors, this can mean buying shares in a company that holds good fundamental value such as earnings, sales and cash flows at a cheaper price with a longer-term view of that company’s share price increasing in the future,” says DMA’s Christopher Clarke.
“A good example of a sector that tends to remain healthy in a recession are consumer staples such as basic goods that support everyday living. Think companies like Tiger Brands or Walmart where their main form of business is the manufacturing a distribution of necessities like food. Other classic examples of sectors that do well in recessions are companies in the health care, energy and IT fields.”
But because no one knows exactly how the stock market is going to perform, or when the bottom of the market has been reached, investing under these circumstances should only be done if you’ve ticked a few boxes.
- Firstly, ensure that you have emergency savings in place that could get you through a few months. If you have extra cash left over after making this provision, then perhaps give the stock market a try.
- Again, invest with a long-term mindset. During a recession volatility is the name of the game, so don’t be surprised if your stock picks don’t behave the way you’d like. If you’re not expecting immediate returns then you’re likely to be better off.