News & Insights

There’s been a lot of talk about recession – how can I safeguard my money?

In our new monthly feature, Market Matters, we answer your investment questions. In our first feature, Ravenscroft CIO Kevin Boscher explains recession and what this could mean for investors.

For some time now, investors have been concerned about the prospect of markets entering a recession. The key question for many is what this could mean for their investments.

What is a recession?

The standard definition of a recession is “a period of temporary economic decline during which trade, consumption and industrial activity are reduced, generally identified by two consecutive quarters of negative GDP growth”. However, such a narrow definition can be misleading, and the US National Bureau of Economic Research (NBER) has defined a recession more broadly as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” This is then measured by a wide range of data, including real personal incomes, payrolls, wholesale and retail sales, real consumption expenditures and industrial production.

It is sensible for the NBER to use a wider range of data since focusing solely on GDP fluctuations can be misleading. For example, in the summer of 2022, US GDP fell by 1.6% in the first quarter and by 0.6% in the second, hence technically indicating a recession. However, at the same time, with employment growth very strong (and unemployment very low), inflation accelerating to 9.1%, and retail sales and other consumption indicators expanding, it certainly didn’t feel like a recession.

In normal times, market economies are driven by a virtuous circle of positive economic growth which creates more employment, rising incomes, more demand, higher investment and so another round of positive growth.
In a recession, this sequence reverses and becomes a vicious downward spiral, which leads to job losses, deteriorating personal incomes and wealth, falling corporate earnings, lower corporate investment, and deflating asset prices.
However, a recession also usually leads to falling inflation, which of course would be welcome in the current environment. Usually, the catalyst which can flip an economy from a period of expansion to recession is a reversal in employment and, therefore, in personal incomes. Jobs and income normally move in the same direction as GDP growth, especially in the US and UK economies, where consumption makes up roughly two thirds of economic activity. 

It is worthy of note that since World War II, a full-scale recession (as defined by the NBER) has followed on from two quarters of negative growth in all but two cases: in 1947 after a post-war boom and in 2022, after the Covid reopening. It is also important to remember that GDP growth is measured in real (after inflation) terms so in a period of high inflation, nominal growth can remain positive (as incomes and prices rise) but real growth may decline and turn negative.  

How can I safeguard my investments during a recession?  

Recent economic data is clearly pointing to weaker growth and the rising possibility of a recession in the US, UK and Europe over the coming months. Hence, it is prudent to be cautious and plan for at least a mild recession. As already explained, there are different forms of a recession and not every type is bad for markets. A deep and prolonged recession, which involves a downward spiral of activity across the whole economy as outlined above, would normally be bad for corporate profits, and hence equities, although some sectors, such as quality defensive companies and utilities would usually outperform. A short and shallow recession, on the other hand, would have less of a negative impact on earnings and stocks.

In addition, the performance of equities during a period of negative activity will depend on other variables such as the direction and level of interest rates, inflation, valuations, and liquidity. For example, if the US goes into recession over the coming months, then the Fed might reverse policy quickly and cut rates aggressively at the same time as adding liquidity to the system, especially if inflation is falling back towards target at the same time. This could be bullish for equites with interest rate sensitive sectors such as technology and healthcare leading the way.

Bonds could be expected to outperform equities in a recession, since negative growth should lead to falling inflation and lower interest rates. Care is required, however in corporate credit markets, since falling margins and profits could result in rising debt defaults and yield spreads (the difference between a government bond and the equivalent maturity corporate bond). Also, bonds might not do as well as expected in a period of stagflation, where recession is accompanied by high and “sticky” inflation, making it difficult for central banks to cut rates. We may well be entering such a period.  Generally, investors would be wise to hold a bit more cash during a recession as a defensive asset class and to provide liquidity to re-invest back into markets as opportunities emerge.

Given that the global economy has never been through a pandemic followed by a war, inflation shock and energy crisis before, the global economy and markets are experiencing elevated levels of uncertainty and volatility. Hence, investments will probably behave very differently over the next decade to what we have experienced previously. Therefore, at times like this, it is prudent to take a longer-term view, ensure your risk and return objectives remain appropriate, try to achieve a balanced and diverse portfolio, and seek guidance from your professional investment advisors.

If you’d like to find out more about investing with Ravenscroft, or if you have any questions you’d like us to answer, please contact us.