“Are we really in a recession?” This popular topic has been pounding around the market since the beginning of the year. The occurrence of a recession depends on a variety of complex economic and political factors such as employment rate, personal income, inflation, and GDP growth that can be difficult to predict. Based on a survey by NABE in December 2022, majority of respondents believes there is more than a 50% probability that the United States will enter a recession in 2023.
However, it is often said that a recession is defined by two or more consecutive quarters of decreasing GDP, which we already saw in the first half of 2022. According to International Monetary Fund (IMF), the world economy is projected to see just 2.9% GDP growth in 2023, down from 3.2% projected for 2022. IMF also stated that 2023 will feel like a recession for much of the global economy but whether it is headed for a recovery or a sharper decline remains unknown.
The Better Choices During Recession
While no investment is guaranteed to be recession-proof, some sectors tend to outperform the others as consumer needs shift during recession. Both healthcare (including biotech and pharmaceutical) and consumer staples (including F&B, household, personal products, alcohol and tobacco) sectors are best representatives for this scenario. These sectors are typically unattractive during boom periods (bull market), but they are defensive stocks where companies sell items everyone buys no matter the economic circumstances.
Stocks with decent dividend yields and high dividend cover ratios can be very effective recession-proof investments. Stocks with positive dividend growth can be a sign of financial strength and discipline, low-debt, strong balance sheet, positive cash flow and profitability which may help a company survive and withstand through difficult economic times. An attractive dividend yield must always be backed up by sustainable, positive cash flows. The higher the dividend cover ratio the better as there is less chance of the dividend being cut.
Investing in Exchange-Traded Funds (ETFs) and Low-Cost Index Funds can be less risky compared to investing in individual stocks as these funds give exposure to specific baskets of securities rather than just single investment. In times of recession, it is best to invest in several companies within the most resilient sectors while avoiding concentrating all the risk in one single company. These funds allow for the stronger performance companies to offset the losses of underperformed companies.
Bonds, whether issued by the Government or a corporation, are essentially loans. Treasury bonds are a traditional safe haven asset and will often outperform early on during a recession. They carry the highest credit rating and benefit when central banks cut rates. When the bond matures, investors will get back the initial amount they invested plus the interest. In some cases, investors can choose to sell the bond to another investor on the secondary market before its maturity date.
In recent years, there is growing evidence suggesting environmental, social and governance (ESG) factors affect the long-term value of a company and ESG investing is rapidly becoming a viable compliment to factor investing. Evidence suggests that management teams that take ESG issues seriously often made decisions that minimise risk for the companies. Since investing during a recession involves moving to assets with lower risk, these companies tend to outperform. Therefore, stocks with high ESG scores may be one of the proven recession-proof investments.
The Bottom Line
Investing during a recession can be excruciating without a plan but with a well-diversified portfolio and prompt tactical changes, investing during recession can make good profit. Look for long term opportunities during the financial crisis because they do not come along that often. It is crucial to remain calm and not panic and trust the market’s resilience and the diversification that is built in your long-term portfolio.