Investing During A RecessionApril, 19 2023
Recessions are times when economic activity contracts, corporate profits decline, unemployment rises, and credit for businesses and consumers becomes scarce. During the 11 recessions the US has endured since 1950, stocks have historically fallen an average 15% a year.
This history may suggest that selling stocks before a recession arrives and buying them after it departs would be a smart strategy. But savvy investors know that it is extremely difficult to do this successfully and often a recipe for locking in losses instead. Rather, the approach of a recession is a good time to set realistic expectations for what may lie ahead, review your portfolio, and carefully make any moves that may be necessary to make sure it remains aligned with your long-term goals. While recessions can’t be avoided, there are things you can do—and things you shouldn’t do—to reduce their impact on your finances.
Like a hurricane
The first thing to do as a recession approaches is to resist anxiety and fear. People fear recessions because of the layoffs and volatile markets that accompany them, but fear is neither a good basis for making investment decisions, nor a reason to be unprepared when a recession arrives. Much like tropical depressions that gradually strengthen into powerful storms, signs of an approaching recession can be seen well in advance of its arrival and investors and consumers can take steps to get ready.
While recessions don’t last long—only 9 months on average—they can pummel portfolios that have too much exposure to some types of assets and not enough to others. Over the long run, stocks have historically delivered the highest returns of any asset class, but they have also historically been the worst performers during recessions, trailing both bonds and cash. With history as a guide, here’s what you might expect from your portfolio when an eventual recession arrives.
Investment returns before, during, and after recessions
Bonds in recessions
In every recession since 1950, bonds have delivered higher returns than stocks and cash. That’s partly because the Federal Reserve and other central banks have often cut interest rates in hopes of stimulating economic activity during a recession. Rate cuts typically cause bond yields to fall and bond prices to rise.
For investors in or nearing retirement who want to reduce their exposure to stock market volatility, the period before a recession may be a good time to consider shifting some money from stocks to bonds. That’s because the Fed is typically raising interest rates to slow growth, which means lower bond prices and higher yields.
Keep in mind, though, that the bond universe is a far more vast and variegated place than the stock market and not all bonds perform equally well during recessions. Investment-grade corporate bonds and government bonds such as US Treasurys have historically delivered higher returns during recessions than high-yield corporate bonds.
We can expects that prices of high-quality corporate bonds will recover strongly once the economy and inflation slow, and Fed begins cutting rates to stimulate growth.
Cash in recessions
While maintaining a large allocation to cash is not a good long-term strategy for most investors, cash held in certificates of deposit (CDs) and money market funds has historically provided a cushion against market downturns during recessions. In the late phase of the economic cycle which precedes a downturn, interest rates typically reach their highest levels. For investors who want to earn income while preserving capital it may be a good time to consider purchasing longer-term CDs which can provide income through a recession and beyond.
Money market funds are another option for holding on to cash during a recession. While their yields may eventually fall when interest rates do, they can offer protection for your capital and easy access to your cash when longer-term investment opportunities reappear.
Stoks in Recession
Overall, stocks have usually struggled during recessions. Stocks of companies in industries such as technology and media which consumers and businesses can postpone spending money on have been among the worst performers during recessions. Financial stocks have also historically found the going difficult.
Not all stocks have weathered recessions badly, however. Stocks of companies that make and sell goods and services such as food, healthcare, and electricity that people need to purchase regardless of the state of their personal finances or the phase of the business cycle have performed relatively well compared to other categories of stocks during recessions.
Surprisingly, perhaps, consumer discretionary stocks—travel, clothing, housewares, and other non-essential products have also fared better during recessions than they have in the period immediately preceding a downturn when they have often sold off in anticipation of bad times ahead.
Stocks of companies that obtain much of their revenues from outside the US may also be worth considering in the period prior to a recession.
While the US has yet to enter recession, other parts of the world such as the EU have likely already been in recession and will likely recover before the US. Typically, markets recover from a recession well in advance of the return of economic growth so international stocks may offer recession-wary US investors the opportunity to potentially diversify away some risk.
Choose Your Corresponding Sectors
Sectors are defined by the Global Industry Classification Standard (GICS®). Source: Fidelity Investments
While there are investment moves you can make in advance of a recession, it can also be a risky time to pursue higher yielding assets. Rather, consider reducing risk by diversifying your portfolio with bonds and cash.
The late or “pre-recession” phase of the business cycle is historically a time of abrupt and unforeseen market moves. Also, loading up on the asset classes that have historically delivered the highest returns during recessions may mean adding more exposure to assets that may be among the weakest performers when recession gives way to renewed economic growth during the early cycle that follows a recession.
STRATEGY : Take the time to look ahead
To help manage the anxiety and fear that may arise from watching the market and economy as they move fitfully toward recession and the eventual start of the early cycle, it’s helpful to have a long-term asset allocation plan as part of a broader financial plan. An appropriate asset allocation includes a mix of stocks, bonds, and cash that aligns with your goals, time horizon, and your ability to manage risk. Your plan can help you avoid emotional overreactions to volatility so you can stay on track toward your long-term financial goals.
What that plan looks like may depend on who you are. For investors who are a decade or more from needing the money in their portfolios to help pay for their living expenses in retirement, recession-related volatility may represent a chance to buy high-quality stocks at discount prices in hopes that they will rise as times improve. However, the entry into recession may have more implications for the portfolios of those near or in retirement who may not feel that they can afford to wait for an eventual recovery in the value of their stocks.
While individual investors should be cautious about making changes to their asset allocations during the late and recession phases of the business cycle, professional managers such as the investment team at Investlogic do adjust the portfolios they manage to reflect their views about where the economy is in the cycle.
These so-called cyclical allocation tilts involve carefully adding or reducing exposure to various categories of stocks, bonds, and short-term assets. Adjustments of these sorts typically are only made within the context of a long-term strategic investment strategy. That’s because the forces that move markets are constantly in motion and the investments that perform best have historically varied with the expansion and contraction of economic activity.