How Recessions Impact Investors

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key takeaways

  • Despite the hype, stock market declines make poor indicators of a potential recession
  • Understanding how stocks, the economy and the business cycle interact can help broaden your financial understanding.
  • If a recession strikes, investing in defensive positions, dividend-paying investments and real estate can help you weather the fall.
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The stock market continues to encroach on bear market territory, with the S&P 500 down nearly 18% since January. The Nasdaq-100 is already enjoying a picnic with the bears, with a six-month decline of 29%. And some investors think that current bond activity paired with rising interest rates poses trouble on the horizon.

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During periods of such high volatility, it is natural to worry about a future market crash or economic downturn. This is doubly true as inflation nears a 40-year high and there is respite in the housing market.

But in reality, stock market declines are poor indicators of a potential recession. For example, the market declined before the 2001 recession, but avoided bear country before the 6% recession between 1953-1990. In addition, a stock market crash flagged three false warnings between 1962 and 1987.

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Understanding how stocks and the economy interact can help you deepen your understanding of both. And that doesn’t mean you should ignore falling markets – often, they’re a symptom of an underlying problem. (In this case, investor and consumer pessimism.)

And even if you’re feeling good about your future financial prospects, it’s important to know how a recession affects investors.

bearish and falling markets

Stock market performance is based on investor expectations, business fundamentals and market cycles. And while we often associate rising stocks with good times and declining stocks with bad, this is not always true. In fact, 7 out of 13 recessions since 1945 have delivered gains – not losses.

In other words, a recession is not always preceded by a bear market. (Though both can feed each other under the wrong circumstances.)

Recession can strike any country at any time and can be caused by economic imbalance, financial crisis, pandemic or trade war. During these periods, consumer and business spending, employment rates and wages generally fall, leading to a reduction in economic output.

Additionally, recessions do not affect economies equally. For example, necessities such as groceries and utilities often perform well, while cyclical industries such as travel suffer more.

recession and business cycle

Both recession and expansion are part of the normal economic cycle. Generally, recessions last about 10 months on average, while extensions can last from a few months to a decade.

To understand how a recession affects investors, it’s helpful to understand the basic economic cycle:

  • Stage 1 – Peak: During the peak, the economy enjoys high employment, rising income and GDP, and moderate to high inflation. The stock market can perform well as businesses enjoy large profits.
  • Stage 2 – Recession: After a period of growth, income, employment and GDP decline. Stock prices may fall as businesses report layoffs and shrinking profits. Markets can be volatile and experience wild swings.
  • Stage 3 – Trough: Once spending and investment activities have calmed down, the recession is over. Businesses and stocks go into recovery mode as lower prices attract consumers and investors alike.
  • Stage 4 – Recovery and Expansion: The economy grows again as wages, borrowing and spending increase. Businesses hire more workers and drive innovation, making inflation low and slow to start.

current headwind

The United States – and the rest of the world – is in an unusual place at the moment. While we have enjoyed high wage growth and record-breaking business profits over the past year, we are also facing supply chain constraints in every industry, surging inflation and sky-high housing and investment markets.

Unfortunately, much of this growth appears to be growth for the sake of growth. In other words, market prices can no longer be supported by the underlying fundamentals.

However, none of these headwinds alone are enough to throw us into a recession. Instead, if we do face a recession, it will likely be due to all of these factors heating up the economy at once, followed by a drastic recovery due to the Federal Reserve raising interest rates. Already, many have predicted that there will be no “soft landing” after two years of astronomical gains and performance.

stand in a position of strength

Despite so many adversities, many American families are grappling with a potential recession.

Although high inflation continued to pinch many in the pocketbook, 2021 also produced Biggest GDP growth since 1984, In fact, the US economy is 3% larger than in 2019, even accounting for the 2020 stay-at-home economy.

In addition, new data shows that much of last year’s growth burrowed its way into Americans’ pockets. The bottom half of the country continues to see independent gains from pandemic stimulus, according to the latest estimates.

After adjusting for inflation, the lowest 50% on the national ladder saw labor and capital income increase by 10.9 percent last year. Thanks to increased employer competition, wage benefits positively impacted the bottom 25% of Americans in 2021. Not to mention, reports from ADP Research Institute And Labour Department Suggestions suggest US wages rose 4% across the board last year.

And if that wasn’t enough, the American people now have the infrastructure, skills and training to work from home in the event of potential layoffs.

In other words, if we see a recession, it will not be from a position of weakness, but from a position of strength.

investing during recession

But even if your personal finances are fine, it’s a good idea to protect your invested capital when the economy goes down. And while recession-proof investing doesn’t exist, some securities and strategies can weather the storm better than others.

assume a (defensive) position

One way to profit (or minimize losses) in a downturn is to take defensive positions. This strategy is especially useful for risk-averse and retirement-age investors.

Cash and fixed income investments such as CDs, Treasury and money market funds can all help protect your funds. Non-cyclical investments such as utilities, healthcare, energy, financial and consumer goods could also weather the fall with minimal losses.

However, if the market turns bullish, you run the risk of missing out on potential gains.

buy in dividends

Holding dividend stocks can not only minimize bearish losses but also maximize your lifetime returns. Dividends generate passive income that can increase your profits even when prices are low.

Specifically, you can look for Dividend Elite, which are companies that have increased their dividends annually for at least 25 consecutive years.

real estate

When a recession hits and housing prices fall, you have a chance to snatch real estate for cheap. But you don’t have to change houses or rent out the property to make a profit. Real estate investment trusts (REITs) let you take advantage of the hard work of others without getting your hands dirty. (Just beware of high tax rates.)

price strategies

Value investors view declining shares as a bargain. Betting on quality stocks at low prices means that, when the economy recovers, you could see even higher returns. (Even though they may take a few years to materialize.)

buy-and-hold strategies

Another way to deal with the recession is…no. Many buy-and-hold investors view a recession as little more than a short-term decline in their long-term horizon. As such, they primarily buy investments they are prepared to put through thick and thin and ignore the news.

Don’t let the recession hit you (too much)

It’s easy to get overwhelmed by doomsday headlines in uncertain times. But a deep breath and a memory of your long-term plan can make your life less terrifying. In fact, long-term investors should not view a recession as a threat — rather, an opportunity.

Still, it doesn’t make the meltdown any easier emotionally. So you have

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