Is It A Good Idea To Buy Stocks Before a Recession? When the economy takes a plunge and a recession is on the cards, it’s natural to feel uncertain about where to put your money.
In fact, stocks can perform unpredictably, and it’s important to consider a wide range of strategies to help you survive these volatile times.
Below, we’ll discuss the impact of a downturn on your portfolio – and look at ways to profit from defensive stocks and other alternative securities.
What Happens In A Bear Market?
A recession is typically defined as a period of economic decline, often characterized by a fall in gross domestic product for two or more consecutive quarters. During this time, businesses and consumers will cut back on spending, leading to job losses and a decrease in overall economic activity.
Indeed, when it comes to the stock market, a recession can have a significant impact on share prices too. Historically, company valuations tend to contract in the early stages of a slump, as investors become more cautious and begin to offload their holdings.
However, it’s important to note that stocks don’t always move in sync with the overall economy. In fact, because investors can look at forward-facing financial metrics, the market can start to recover even before the economy actually does.
Moreover, not only does the data show that stock prices are inclined to drop during a recession, but the magnitude and duration of the pullback also varies. For example, during the 2008 financial crisis, the S&P 500 index fell by approximately 50% over a 17-month period. However, during the milder boom-and-bust of 2001, it only registered a 27% decline over a 9-month span.
Strategies For Investing
Just before a recession starts to bite, it can be a good idea for investors to consider a defensive approach to stock picking, focusing on companies and sectors that perform well during episodes of diminished growth.
Indeed, a defensive sector is a group of companies that produce goods and services that are considered essential and, therefore, less sensitive to economic cycles. These firms sport steady cash flows, and are assumed to be safer than businesses in industries such as technology and entertainment.
Examples of defensive sectors would include healthcare, consumer staples and utilities. These companies produce and sell non-discretionary goods, such as food and medicines, or provide essential services like electricity, gas and healthcare.
On the other hand, while cyclical sectors – which closely mimic the overall state of the economy – seemingly perform poorly during a crunch, they often have strong growth prospects and can be a good investment opportunity if bought when the market is at its lowest.
Alternatives To Buying Stocks Before A Recession?
During a term of economic uncertainty, investors may want to consider alternative investments as a way to profit and add variety to their portfolio. These substitutes – such as bonds, real estate, and commodities – can present an opportunity for investors to make money even when stocks are declining or show little prospect for recovery.
For example, in a recessionary environment, fixed-income securities such as bonds are seen to be a safer investment option as they exhibit an inverse correlation with interest rates. Therefore, as interest rates decrease, bond prices have a propensity to rise.
This dynamic is primarily driven by the monetary policy response of central banks during an economic downturn. As the economy weakens, central banks are prone to lower interest rates in an effort to stimulate economic activity. As a result, the yield on existing bonds decreases, leading to an increase in bond prices. This presents an opportunity for investors to generate returns through capital appreciation and a reliable flow of income.
Real estate investment trusts and direct property investments also present attractive alternatives during a recession too.
Compared to equities, real estate tends to display reduced volatility and can provide a stable revenue stream through rental payments.
Additionally, while property values may fluctuate, they often do so at a lower rate than equities in a bear market. This is due to the relatively inelastic demand for housing – especially rental properties – which remains stable even when the broader market is in turmoil.
Furthermore, real estate investments can provide the potential for long-term capital appreciation through property price inflation and rental income growth.
Commodity investments, such as precious metals and hydrocarbons, can serve as a diversification tool for investors during a slowdown in expansion.
Indeed, these securities demonstrate a lower correlation with typical equity price movements and can provide a good hedge when everything else is going to the wall. For instance, gold, due to its historic role as a store of value, has long been considered a traditional safe haven during times of economic uncertainty, with investors flocking to it as a means of preserving their funds.
Similarly, energy commodities, like oil and gas, are attractive forms of investment when other asset classes are underperforming. The finite nature of these resources results in relatively stable pricing even when conditions are especially onerous. Additionally, the prospect of a rebound in economic activity following a recessionary chapter can also lead to an increase in demand and a corresponding spike in commodity value.
Is It A Good Idea To Buy Stocks Before a Recession?
Ultimately, trying to invest during a recession can be a challenging endeavor. However, by considering defensive stocks and looking at alternative investments – like government bonds, real estate, and commodities – you can potentially diversify your portfolio and thus lessen your overall exposure to risk.
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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.