BLOG: Why recessions can be great news for investors
Recession fears have been dominating the headlines of late. While this may be fear-inducing, it can also spell good news for investors who are able to use periods like this to buy shares at lower prices.
Firstly, it’s important to cover off what a recession actually is. It is a period where economic activity declines and gross domestic product (GDP) – a measure of an economy’s size and health – falls for two consecutive quarters. It can sound a little scary and, with the highest inflation in 40 years, and with expectations for global economic growth at a record low, isn’t there good reason for investors to be alarmed?
Despite the dire market sentiment, investors should be reminded that although a recession may appear frightening, it is simply a way for markets to recalibrate, and it can have some benefits. For example, a downturn gives investors the opportunity to re-evaluate how their investment portfolio is positioned and to reposition for a market recovery.
In volatile markets there are always going to be winners and losers. Don’t forget that it can be dangerous to invest based on the good news over the short-term and to lose sight of stocks which offer excellent growth potential over the long-term. Chasing short-term returns and second guessing the market is fraught with danger and is to be avoided at all costs.
It is impossible to predict which event will next wreak havoc on markets, whether it be war or a global pandemic. Investing is for the long-term and attempting to time the market is a risky strategy. Investors should do their best to ignore volatility in the markets because changing the positioning of your portfolio based on short-term movements is highly speculative.
It is much better to stay invested and to simply ignore any short-term drops or rises in portfolios. Consider the fact that since 1927, the US equity market has only spent 5% of its time in a bear market. Holding a well-diversified portfolio for the long-term helps you to average out any fluctuations along the way and will ensure that you are protected.
Trust in your strategy
It is, of course, all too easy for investors to be distracted by media noise, friends’ advice or their own recession fears. Don’t lose sight of your investment objectives and your appetite for taking on risk.
The main reason financial planners, portfolio managers and digital wealth managers ask prospective investors questions about their capacity for loss before selecting an investment strategy is to understand how they will behave when markets fall. As the fathers of behavioural economics, Daniel Kahneman and Amos Tversky, put it: “losses loom larger than gains.”
Professional investors know that a lifetime of investing involves periods when even the best investors will lose money. Their task is to make sure their clients know that too. But it’s also worth remembering that investing is a zero-sum game, meaning that on the other side of a panicked investor selling their stock as its value tumbles, is another investor snapping up a bargain.
As Warren Buffet noted: “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”
When recessions come around, it shouldn’t be the value of your portfolio that’s the worry, but your own ability to keep your head and stick to your plan.
Recessions also create opportunities to find quality companies at a discount. Many do this using ‘fundamental analysis’, a framework for valuing a company based on several metrics, such as its management and future financial strength.
Investment managers who hold well-researched, quality businesses have the potential to outperform market indices in challenging conditions. We believe that quality businesses like Alphabet (Google’s parent), Paypal and Heineken have durable business models and competitive advantages in their respective industries, which means they should be able to weather a recession better.
Don’t put your eggs in one basket
It is almost unheard of for bond, equity, commodity and property markets to all be up or down at the same time, whether that is during a recession or a bull market. While you might lose money in one asset class at a given time, you are likely to gain in another.
This is why diversification is crucial. By maintaining a portfolio with a variety of investments, you are limiting any potential impact brought about by short-term market fluctuations. You reduce risk by spreading your investments across different sectors, geographies, and asset classes.
The top tips we are giving to our clients right now is to stay invested, have a cash buffer, keep buying into the market, diversify – and finally, don’t panic!
While the prospect of a recession is rightly daunting, the savvy investor has a rare opportunity to capitalise.
Eleanor Davis is a financial analyst at Sanlam Wealth