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Guide To Navigating Recession In The Right Way

Asefa Hafeez
Recession

Before we delve into what sectors and stock types we should invest in, let’s define what a recession is. When a nation experiences two consecutive quarters of negative growth, it has entered a recession. But with this comes an entirely new set of issues.

 

Negative growth not only prevents the creation of new jobs for citizens but also results in the loss of existing jobs. This results in an entirely new set of issues. As panic grows, citizens become more prudent in their spending practices. In addition to fewer investments being made, citizens remove their existing investments and savings in order to weather the storm.

 

 

In addition, investors that follow the herd panic and liquidate their holdings when share prices collapse during a large sell-off. Further,  a recession carries with it additional difficulties, such as inflation, which make the problems more difficult to manage.

 

When the economy is thriving, your investments would provide substantial profits. In contrast, when the market declines, fixed-income instruments tend to offer lower interest rates, loan EMIs increase, and the portfolio tends to display more red than green. Although these downturns are temporary, they can be costly for investors because they put them on the path to the most feared word: recession!

 

During a recession, the economy struggles, individuals lose their jobs, companies generate fewer sales, and the nation’s economic output declines. Numerous factors decide when the economy officially enters a recession, but that is a topic for another day. The leading indication, for the time being, is a decline in the Gross Domestic Product (GDP) for two consecutive quarters.

 

The Great Recession of 2008 is a classic illustration of the relationship between recessions and markets. Simply put, an overheated economy causes inflation, which ultimately leads to a recession! Therefore, as an investor, how can you safeguard your capital in such circumstances? Let’s kick this dialogue off!

 

Reason for Recession

 

Inflationary pressures, supply chain restrictions, a lingering pandemic, and the recent Russia-Ukraine conflict have contributed to an economic crisis, predicting a substantial deceleration in global GDP growth and inflation in 2022. Moreover, fuel and food prices have risen sharply, disproportionately impacting disadvantaged populations in low-income nations like India.

 

According to the International Monetary Fund (IMF), global growth would decelerate from 3.6% in 2022-23 to 3.3% in the years following 2023. Inflation forecasts for 2022 are also projected to be close to 5.7% in developed economies and 8.7% in emerging nations. This change is a result of rising commodity costs and intensifying price pressure.

 

Global recessionary patterns continue, with the US GDP dropping at a rate of 1.4% in the first quarter of 2022, well below the anticipated growth of 1%. On the other map, the UK’s GDP decreased by 0.1% in March, following a 0.0% growth in February. According to economists at JP Morgan, the US economy and European markets have a 70% likelihood of entering a recession. Under the Indian context, according to IMF, the Indian economy is strongly placed and immune to recession in the current scenario. However, RBI has predicted an inflation rate of 6.7%  for FY 2022-2023.

 

 

Investment Strategies To Adopt During A Recession

 

For investors, the warning indications of a predicted recession might be unsettling. However, the important question is what an investor can do in such a circumstance. Continue reading to discover!

 

 

On the flip side, when the market is down due to a recession, it might be a great moment to buy high-quality stocks at a discounted rate. This does not suggest that you invest blindly in any company. A company with the worst-performing assets is under a lot of strain, which could eventually cause it to fail. A top-notch business has a solid balance sheet, low debts, and the capacity to withstand adverse conditions. Before making an investment, investors should conduct extensive research about the company’s profile and accordingly, consult with their financial advisor.

 

 

Investors can choose to invest through mutual funds rather than trying to buy individual stocks (even if they are offered at a discount). After a recession, stock markets typically experience a broad-based recovery (several stocks go up together). Instead of placing your money on just a few stocks, it is advisable to invest in a diversified mutual fund where you may take advantage of the broad-based recovery. This strategy’s return would be lower than that of some of the top-performing equities in the returns table. But, it will provide you with the safety net of a well-diversified portfolio.

 

 

Investing in funds, such as sector-specific funds, exchange-traded funds, and low-cost index funds, is frequently less risky than investing in individual equities, which may be particularly appealing during a recession. Investing in funds exposes you to certain baskets of securities, as opposed to a single investment (such as an individual stock). This is one strategy to invest in numerous companies in the most robust industries during a recession without concentrating your risk on any one company. If one business in the portfolio underperforms, the good performance of other companies can counterbalance the underperformer’s losses.

 

During times of recession, it is quite evident that certain sectors perform better than others. There will always be a section of an economy that will boom during a financial or economic crisis. For instance, the Pharma sector performed exceptionally well during the covid-19 pandemic. Similarly, the utility sector, healthcare sector, infrastructure sector, etc may somewhat be immune during a recession. Therefore, to a certain extent, it would be prudent to invest in certain sector-specific mutual funds to build long-term wealth during recessionary times.

 

 

When the economy is recovering, think about leveraging the recession to your advantage. It is commonly known that once the market declines, it does not rise to its previous level in a short span. The path to recovery is one in which the market expands as the economy grows. When interest rates are lowered, the market can then start to see growth. Companies with strong financial standing and little debt would have survived the slump. Until this point, investors must restrain their emotions and follow professional advice regarding their holdings.

 

 

The real estate industry is not immune to the recession, like most other economic sectors. The financial crisis of 2008 is evidence. Commercial and residential assets lose value during a recession because they become unattractive. However, there is a missed chance here.So, consider: why did you initially wish to invest? Was it not for financial gain? One of the finest investments during a recession, according to experts, is real estate. Why do you inquire? because real estate sells for less during a downturn. Therefore, taking advantage of the chance would pay out handsomely whenever the real estate industry begins to recover.

 

 

During an economic downturn, stock markets hit rock bottom, which may dissuade you from buying stocks. However, experts feel that a recession is an ideal opportunity to buy/hold equities with a long-term outlook and not to entirely liquidate stock investments. A few industries flourish even during economic downturns and deliver satisfactory results. What industries are these then? Those that produce necessities. During a recession, would you go without food and water and refuse medical care? Absolutely not.

 

 

 

During recessions, investors often gravitate toward fixed-income investments (such as bonds) and dividend-yielding investments (such as dividend stocks) because they provide regular cash payments.

 

Dividend stocks are shares of a company that distributes a portion of its profit according to the number of shares owned by each owner. Investing in companies with a history of paying and rising dividends might result in reliable income flow even during economic downturns. There is also the option of investing in dividend ETFs, which are comprised of companies that are known for frequently paying high dividends. And while these payments can be withdrawn as cash and used as income, there is an additional component that makes dividends more enticing during volatile times.

 

Reinvesting dividends is a benefit of investing in dividend-paying stocks, mutual funds, and ETFs. Even if the value of your stock falls due to market conditions, reinvested dividends reduce volatility. Suppose the stock market is down 10 percent, but the dividend yield on the stock you own is 3 percent. If this is reinvested, you will experience less of a loss and get the benefit of compounding in the long term.

 

When searching for dividend-paying companies, it is essential to keep in mind that yield should not be the deciding factor, as the highest yields tend to be accompanied by increased risk. Instead, look for regularity in dividend payments or increases, which is indicative of excellent corporate governance.

 

 

Diversifying your portfolio will always help to lower your risk. Investors frequently turn to gold as a safe haven during uncertain times, as evidenced by the recent dramatic increase in gold’s price. According to experts, investors should hold between 10 and 15 percent of their portfolio in gold during high inflation and recession. Investors who have some exposure to gold would have been partially protected from the recent equity market decline.

 

However, stay away from purchasing actual gold (bullion or ornaments) because the production and maintenance costs reduce returns and raise concerns about safety, liquidity, and purity. Consider financial assets like gold sovereign bonds or gold exchange-traded funds while investing in gold. These offer an extremely high level of convenience and safety while enabling investors to buy gold in denominations as low as 1 gram. It is also believed that gold should not be a seasonal exposure; having some investment in gold merely as part of your overall asset allocation is considered good economics.

 

Investing in foreign equities, particularly US companies, is an additional strategy for portfolio diversification. US-focused stock funds offer two key advantages: By making investments in a different nation whose market has little resemblance to the home market, they contribute to geographical diversity. They additionally offer currency diversity. Even if you invest and redeem in rupees, investments in equity funds with a US focus are denominated in dollars. The actual NAV return of the fund is increased by the tendency of the local currency to fall over time relative to the dollar. US-Stocks offer the best means of hedging currency risk for Indian households looking to spend dollars in the future.

 

Stocks That Historically Have Performed Well During Recession

 

 

Regardless of the period that the economy is experiencing, certain products are indispensable. Even if consumers reduce spending money on fancy restaurants, they will continue to purchase food necessities. People are still required to purchase toothpaste, soap, shampoo detergent, dish soap, etc. Stocks of hosiery flourished during the covid period, which was an additional intriguing fact. As a result of the lockdowns, everyone was confined to their residences. As distressing as the lockdowns were, everyone did their best to stay warm and snug at home in their undergarments. This enhanced the prospects of these companies.

 

As these items are always in demand regardless of the economic climate, they are known as consumer staples. When it comes to investing during a recession, this industry is historically has been the first pick of investors.

 

 

Here’s where it helps to be astute. There must be a place to buy the necessities. By itself, this makes the store offering these goods a good place to invest during a recession. The covid-19 crash revealed that RK Damani, a billionaire, was one of the few people in the world to not only protect his wealth but grow it during the crisis.

 

This was due to the fact that his business, DMart, is a major player in the global retail industry. The business’s operational strategy is unique. DMart only sells goods with a short shelf life. This indicates that a sizable amount of their product line consists of household essentials.

 

 

The pharmaceutical sector, like consumer staples, does not experience a decline in demand during a recession. People with chronic diseases must continue to receive healthcare, regardless of the economy. Regardless of the origin of the recession, a recessionary economy can only lead to further deterioration of people’s health on all fronts. Unfortunately, this raises interest in new pharmaceutical products.

 

 

It would not be surprising to see this industry on the list after observing the other industries. Products pertaining to power and gas make up another category of necessities whose demand is less impacted than those of other industries. These necessities, such as gasoline and electricity, are crucial and cannot be ignored in the modern world.

 

 

What if a recession could be handled elegantly and stylishly? Yes, you can accomplish this by purchasing shares in companies that manufacture cosmetics and makeup. Yes, the “Lipstick Effect Theory” explains why these products’ sales tend to increase during economic downturns.The Lipstick Effect Theory contends that during a recession, people choose to indulge in minor luxuries that keep them from losing their cool. This is due to the stress caused by any economic downturn. Businesses’ lower revenues and workers’ lower disposable income are the main causes of this stress.

 

These consumers can no longer afford the previous activities where they would have spent on pricey indulgences. Therefore, they can temporarily transfer their spending satisfaction to smaller products like lipstick, cosmetics, clothing, and apparel. Demand can unexpectedly increase during a recession because so many individuals indulge in these goods. These equities are so resistant to recessions.

 

Hindustan Unilever Limited (HUL), Marico, Emami Limited, Dabur, Procter & Gamble Hygiene and Health Care Limited (P&G), Gillette, and other companies are included in this list of stocks. In addition to this, businesses involved in talent development and grooming may qualify as recession-proof stocks.

 

 

In times of a recession, numerous other industries also have a major advantage over others. Investors’ capacity for adaptation is put to the test in this situation. In recent years, technology has also developed into a crucial factor during recessions.

 

Zoom was one of the best instances following the Covid crash. Many businesses were able to continue operating during lockdowns thanks to technology. As a result, the company’s stock surged many times over. Today, a large number of businesses run entirely online. Due to the fact that their performance was unaffected, these proved to be multi-baggers during covid.

 

Another industry that historically has offered protection to investors is the alcohol industry. It has been noted that businesses that offer high-end alcohol typically suffer during recessions. This is due to the fact that during recessions, even though consumers consume less, they switch to other, less expensive brands. This was not the situation in India during COVID, though, when the industry was negatively impacted by the severe lockdowns.

 

Conclusion

 

Recessions and tumultuous markets might be terrifying, but if you’re investing for the long term, it’s most vital to maintain a steady course. In many instances, the best course of action may be to do nothing – to rely on the durability of the market and the diversification of your long-term portfolio.

 

FAQ

 

When the Indian economy experiences a decline for two consecutive quarters, resulting in a decline in the country’s GDP, this phenomenon is known as a recession.

 

A sector fund is an investment fund that only puts money into one type of business or industry.

 

Inflation is the rate of increase in prices over a given period of time. Inflation is typically a broad measure, such as the overall increase in prices or the increase in the cost of living in a country.

 

Interested in how we think about the markets?

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