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Article | 28 November 2022 | Market updates
Alex Burn,
Senior Investment Analyst, Architas
What is a recession?
The definition of a recession is characterised by a significant, widespread and prolonged downturn in economic activity, usually accompanied by a rise in unemployment. Many countries define a technical recession as being two consecutive quarters of negative GDP (gross domestic product) growth. GDP is a measure of a nation’s output.
Conventional wisdom indicates that equities will struggle during a recession, as lower demand hits company profits. However, the reality is more nuanced. While ‘cyclical’ stocks such as industrial companies, which benefit when the economy is growing, may well underperform, stocks in ‘defensive’ sectors, such as consumer staples and healthcare, can prove to be relatively resilient. Providers of everyday services, such as utility and telecoms companies, can also fare relatively well, as demand is likely to be less affected by cuts in spending. Well-run companies with strong balance sheets and a history of paying dividends may also hold up better than growth companies, which can struggle when the economic backdrop becomes less supportive.
Bond markets are often considered to be a safe haven during times of economic distress. The regular income that bonds generate can help smooth returns and protect investors against any volatility in equity markets. In addition, recessions often prompt central banks to boost economic growth by cutting interest rates. This will typically stimulate bond prices. Central banks are currently increasing interest rates to smother inflation, which has triggered a sharp sell off in bonds. Once inflationary pressures start to abate, bond markets could revert to their traditional role of offering guaranteed income and protection against equity market volatility.
Cash is another asset regarded as doing well in a recession, it is important that it forms part of a diversified portfolio. It is also important to remember that if interest rates are lower than inflation (as is currently the case), the purchasing power of cash falls in real or inflation adjusted terms.
Dollar cost averaging can be a useful tool to help ride any market volatility that can go hand in hand with a recession. It involves investing a set amount of money on a regular basis, so that you buy more of an investment when prices are low and less when prices are high. Dollar cost averaging can help remove the emotion of investing, as it reduces the temptation to try to time markets. Over time, dollar cost averaging can reduce risk, especially when markets are volatile.
Architas view
It looks increasingly likely that the global economy is approaching recession. However, a period of negative growth may help to cool some of the factors which have pushed inflation to multi-decade highs. Lower demand could alleviate the supply chain disruptions that emerged as the global economy recovered from the pandemic. Slower growth and reduced manufacturing output will mean lower demand for oil and gas, helping to ease the energy crisis caused by Russia’s invasion of Ukraine. Ultimately, this will be positive for financial markets, although a period of continued volatility can be expected until the picture becomes clearer. In the interim, a balanced, multi-asset approach should continue to help smooth market returns and provide some reassurance during uncertain times.
