The financial markets are constantly changing with the potential for economic conditions to range from rapid growth to precipitous decline. Of course, it is always preferential to be investing in a growing economy, but this is not always the case, and it is completely out of your control. Fortunately, there are certain investment strategies geared towards dealing with an economy on the verge of or in the midst of a recession.
Definition of recession
In general, a recession is a specific period of time marked by a significant decrease in economic activity. Although there may be various definitions of what is considered a recession, most economists will define a recession as two consecutive quarters of declining gross domestic product (GDP).
Characteristics of a recession
During a recession, an economy will experience declines in consumer confidence, weak employment as well as falling or stagnant wage growth. Recessionary periods are also characterized by low sales and production, declining real income and low confidence among businesses. These are less than ideal conditions for investors looking to earn gains on their portfolios.
Risk aversion and overreacting
When signs of an oncoming recession begin to appear, investors tend to become more risk averse in their investing decisions. This could lead many investors to begin selling their positions out of fear. However, it is important you do not overreact to the hints of a future recession. Historically, economic gains have tended to continue much longer than what market participants expect. In fact, most of the large gains tend to come towards the end of the expansionary period preceding a recession.
Best performing asset classes during recessions
During recessionary periods, the types of assets that perform well during expansionary periods tend to underperform. Therefore, you may want to know which asset classes have historically performed well and maintained value during recessions. Generally, asset classes that do not rely as much on economic growth will perform well during times of economic contraction.
Gold and bonds have performed well during recessions of the past. However, each situation is unique and you may want to consult a financial professional. Certain types of stocks tend to perform better than others as well.
Picking stocks for recessions
Choosing the right stocks for your portfolio can help you weather the storm of a recession and will help to maintain the value of your portfolio. Stocks of companies which have a long track record of resilience during recessions of the past may be your best bet when it comes to stock picking in a challenging economic environment.
You should try to find companies with strong balance sheets as well as good cash flow. Also, avoid companies with substantial amounts of debt or those experiencing falling demand for their services or products. Additionally, companies providing consumer staples, such as food, beverages and household goods perform well since consumers will have to purchase these items regardless of the economic conditions.
Once the economy starts to recover, certain assets that were hit hard during the recession will experience rapid growth. You may want to be ready to capitalize on this recovery-induced growth. Usually, commodities, small-cap stocks and growth stocks will see significant appreciation during the recovery period for the economy.
Contact us for a complimentary professional review of your investments. A suitable portfolio may hold various positions appropriate for recessions and some which are appropriate in a growth market.
Any opinions are those of Independent Financial Services and not necessarily those of Raymond James. Expressions of opinion are as of this date and are subject to change without notice. The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Every investor’s situation is unique, and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with a financial advisor about your individual situation.