How To Invest During A Recession – Forbes Advisor

With inflation rising, stock markets falling and gross domestic product (GDP) in the red, pundits are debating whether the US has entered a recession.

While that question lingers, you may be wondering what you can do now to best position your investments to weather stormy economic weather. Here’s what you need to know about investing during a recession.

Is the US already in a recession?

The US has not yet officially entered a recession.

The National Bureau of Economic Research (NBER), an independent nonprofit responsible for determining the beginning and ending points of U.S. recessions, is waiting until enough data becomes available to explain.

NBER defines a recession as “a significant decline in economic activity that is widespread across the economy and lasts longer than a few months.” Exceptions are made for extreme events, such as the sharp contraction in economic activity in February 2020 that led to the intense, albeit short-lived, Covid-19 recession.

Continue reading: Are we already in a recession?

A common indicator of a recession is two consecutive quarters of negative GDP. The US met this criterion in the first half of 2022 – there was GDP growth of -1.6% in the first quarter and growth of -0.6% in the second – but it is important to remember that fact alone does not mean that the country is in recession.

“GDP declines were caused by supply chain disruptions,” said Brian Katz, chief investment officer at The Colony Group. “Inventory adjustments and net trading accounted for most of the negative growth.”

The NBER’s basic definition of a recession also requires a “significant” decline in economic activity, which is not yet the case, according to Michelle Griffith, wealth advisor at Citi Global Wealth.

But that story could change in 2023.

“We’re watching closely to see if the Federal Reserve’s rate hikes earlier this year reduce demand too quickly, which could lead to a recession in 2023,” Katz says.

Rajesh Nakadi, Head of Investments, Global Family Office at BNY Mellon Wealth Management, believes there is “more than just a US recession in 2023.”

What will the next recession look like?

Even if a recession hits soon, Katz says it won’t look like the Great Recession or the dot-com bust of the late 1990s.

Large economic imbalances exacerbated both of these recessions, he says. The dot-com recession was caused by “tech misinvestment,” and a major housing bubble spurred the Great Recession.

Continue reading: How long do recessions last?

“We don’t see these kinds of imbalances anymore today,” says Katz.

He believes that if 2023 does bring a recession, investors can expect it to have less of an impact on markets than previous recessions.

How to invest during a recession

Investors need to plan when structuring their portfolios, even if the next recession turns out to be mild.

Cash is king during a recession

“In economic downturns, cash is king,” said Michelle Griffith, wealth manager at Citi Global Wealth. With companies increasing savings and job losses, “it’s better to play it safe and stock up on CVs during periods of high employment.”

However, selling assets to get cash in anticipation of a recession is risky. You could short sell and remain trapped in cash as markets rise. A better strategy is to switch to assets that are well positioned to weather a recession.

Because of this, it is always advisable to hold a certain portion of your portfolio in cash or highly liquid securities such as a money market fund.

Own defensive stocks in a recession

Consumer discretionary stocks tend to post strong gains when the economy is growing. They’re called cyclical stocks because gains and losses in this group depend on the ups and downs of economic cycles and consumer confidence.

Defensive names in non-cyclical sectors such as utilities and consumer staples are typically spared these ups and downs. During a recession, defensive stocks can help protect your portfolio.

“Companies that sell basic services and goods like groceries, electricity (and) housing are generally non-cyclical and less cyclical,” says Katz.

Sales of consumer goods — groceries, beverages, and household products — are pretty much recession-proof because no matter how bad the economy is, people still need to eat and use toilet paper. Demand for utilities persists even in a recession, helping utilities outperform other stock sectors during a downturn.

“The healthcare sector is resilient through the economic cycle,” NBER analysts wrote in a 2021 report. “If anything, healthcare employment appears to be increasing as counties experience more severe economic downturns.”

Use dollar cost averaging

Dollar cost averaging is an investment strategy where you buy a fixed amount of an asset on a regular basis, regardless of its current price.

Recessions are great opportunities to use a dollar cost-average approach because you buy stocks when prices are falling. You can average dollars in new money, or simply set your dividends to be automatically reinvested in the security, which would serve the same purpose.

Buy high-quality assets during a recession

“Investors should look for quality across asset classes to protect a portfolio during a downturn,” says Katz. “Low beta, high return on investment, and low leverage are hallmarks of quality investing.”

He calls such companies “all-weather companies” that don’t rely on economic growth to thrive or survive. Businesses with high recurring revenue, such as B. subscription-based sales models, are less sensitive to economic downturns.

He says you should avoid companies with high levels of debt because they may struggle to service their debt if revenue and cash flow decline. They could also struggle to refinance debt as it falls due if credit conditions and lending standards tighten.

Avoid growth stocks during a recession

Heading into a potential recession isn’t the right time to own growth stocks.

“Growth stocks, especially profitless companies tied to high growth prospects, perform worse in recessions,” says Nakadi.

Instead, consider income-enhancing investments and dividend-paying stocks.

Invest in dividend stocks

The best dividend stocks provide a cushion for your portfolio during recessions. Even if a company’s share price falls, it can continue to pay dividends.

“Dividends can indicate strength and provide a way to average dollar costs during market volatility,” Griffith says.

Consider actively managed funds

For fund investors, consider switching to more actively managed funds during a recession.

Research shows that most actively managed funds have outperformed their peers by 4.5% to 6.1% per year in down markets, adjusted for risks and expenses.

Bonds and uncorrelated assets

Bonds also tend to do well in recessions, but Katz says to protect against rising defaults by sticking with investment-grade bonds.

“Finally, when traditional asset classes show weakness, really uncorrelated asset classes like royalties, insurance-linked securities and carbon credits can do relatively well,” he says.

Don’t overreact during a recession

Even if a recession looms, no one can know how long it will last or to what extent it will affect the stock market. Often the best way to invest during a recession is by doing what you’ve already done.

“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, not be lashed by short-term market fluctuations and (focused) on your long-term goals,” says Nakadi.