How to Invest During a Recession

Through Hilary SmithInternational banker

DDebate continues as to whether the US economy is currently in recession. By official definition, the world’s largest economy technically entered such territory in April-June by posting a second straight quarter of negative gross domestic product (GDP) growth. With the Eurozone poised to follow suit and deteriorating economic prospects strongly suggest things will get worse before they get better, it’s clear that many of the world’s leading economies are in for a painful winter when we approaching the final quarter of the year. And that ultimately means that investors should be careful when they want to participate in the financial markets.

We’ve seen stock markets take a hit over the past few weeks, with the S&P 500 falling to a two-year low in late September. Such downturns invariably present investors with a number of opportunities to buy undervalued stocks that were oversold in a panicked market climate. This can be accomplished by switching into value stocks, particularly those that pay dividends. Even if a company’s share price continues to fall, it may continue to pay dividends to investors, which can provide investors with a steady stream of income to protect them from another bear market.

Defensive stocks that aren’t as affected by changes in the business cycle make sense even in a recession. “Companies that sell essential services and commodities like groceries, electricity (and) housing are generally non-cyclical and less cyclical,” said Brian Katz, chief investment officer at The Colony Group, who recently spoke to Forbes Advisor. The utilities sector is a particularly popular defender, as people need water, electricity and energy whether the economy is booming or in a slump.

Value stocks can also make sense as a defensive option. “In general, defensive stocks typically have a market beta of less than 1, meaning they will outperform the broader market if the index falls. In contrast, cyclical stocks typically have a market beta greater than 1, meaning they underperform when the index falls,” noted Duncan Lamont, head of strategic research at British wealth management firm Schroders, in June . “Although value investing is often associated with cyclical companies, most ‘bargain’ stocks in the US stock market are actually more defensive than cyclical,” he added, noting that 75 percent of the MSCI USA Value Index’s market cap is bottoming Equity market beta of less than 0.9, compared to just 15 percent for the MSCI USA Growth Index.

However, value investing isn’t always a defensive game, and such stocks can be just as risky as the broader market. “Portfolio risk is typically measured in terms of standard deviation, loss given default and average loss. When you move to a value portfolio ahead of expected volatility, you want those moves to be less risky than the broader market,” financial services firm Capital Group noted in an October 2019 article. “But surprisingly, over the past 10 years, we’re seeing exactly the opposite for both the Russell 1000 Value Index (the most common benchmark for large-cap value investing) and the Morningstar Large Value category (a composite of value-oriented mutual funds). ”

Indeed, historically, US value stocks have below average US growth stocks over the past 50 years of seven official recessions as defined by the National Bureau of Economic Research (NBER): 1973-75, 1980, 1981-82, 1990-91, 2001, 2007-09 and 2020. In an article from September 2nd for the Wall Street JournalProfessor of finance at George Mason University School of Business, Derek Horstmeyer, decided to test which specific asset classes had performed best in two market scenarios over this period – the periods before a recession and during a recession – starting from the US high-yield bonds , US Long Term Bonds, US Short Term Bonds, US Total Equity Fixed Income, US Growth Stocks, US Value Stocks, US Small Cap Stocks, International Stocks and US Large Cap Stocks.

“In the nine months leading up to the onset of a recession, US growth stocks returned an average monthly return of 0.92% (an average annualized return of 11.6%), followed by US small-cap stocks at 0.83% monthly ( 10.4% annualized). The total US fixed income has averaged a monthly return of just 0.48% (5.9% annualized),” Horstmeyer concluded. “But in a recession, US bonds as a whole averaged a monthly return of 0.62% (7.7% annualized), while US growth stocks averaged a monthly return of 0.12% (1.5% annualized). ) scored. Every other stock class we examined had negative returns.”

It’s also worth noting that investors shouldn’t become unduly influenced by short-term market movements, especially if their investment goals span years, if not decades. Markets will periodically decline, perhaps even crashing in the midst of a prolonged downturn. But they inevitably recover, and when they do, they can scale even higher peaks. If you weather the immediate storm, you don’t need to worry too much about temporary market shifts. And if your portfolio includes companies with solid fundamentals that you think will do well over the long term, there’s even less to worry about.

Of course, economic downturns and recessions can cause investors to have tighter access to their funds. In this case, selling certain stocks well before they bottom out will prevent savings from being wiped out. The well-known adage “cash is king” in downturns could also persuade investors to stockpile cash and trim stocks. In any case, sticking to the original investment strategies as much as possible will ensure they remain disciplined at a time when it can be very tempting to cut your losses and run away. Whether the ultimate goal is retirement, the kids’ education, or an emergency, it’s important to remember the main reasons they came to the market in the first place.

And if investors decide to liquidate part of their stock portfolios, it also pays to have a plan to buy back into the market. “It’s impossible to say exactly when markets will rebound — look at the rapid bull market since late March — but you need a plan,” advised David Blanchett, head of fixed income research at Morningstar Investment Management, in one Wall Street Journal Article in September 2020, at a time when the pandemic had triggered a deep recession. “Although everyone’s situation is different, a phased approach could be the right way to slowly get back into the stock market. You should also consider having someone else manage the portfolio (if you tend to react to market movements), which could mean something like a target date fund or managed accounts in a 401(k). Or a financial advisor or robo advisor for funds outside of a defined contribution plan.”

Of course, investors’ decisions will also depend on their particular financial situation. For example, if you have sufficient emergency savings, investing during a recession becomes a lot less stressful. However, if this is not the case, investors should prioritize setting up emergency funds before considering any participation in the financial markets. Similarly, investors will also want to prioritize paying off their debt, especially when the interest on that debt (such as credit cards) exceeds the returns they can expect on their prospective investments.

Ultimately, when markets are in bearish sentiment, deciding where to invest money can be a stressful endeavor. But perhaps more importantly than at any other stage of the economic cycle, investors in a recession need to have solid plans that detail their investment goals, risk tolerance, and return targets — and then, most importantly, make sure they stick to them keep plans. It can be easy to be swayed by hyperbolic media articles warning of complete market crashes and general disasters. But as Rajesh Nakadi, Head of Investments at BNY Mellon Wealth Management’s Global Family Office, said recently forbes“While (recessions) can be challenging for returns and growing wealth, we also see counter-cyclical rallies and the market is always forward looking so it is important to stay fully invested and not let short-term market turbulence get you down Focus on Your long-term goals.”