What is a recession?

The technical definition of a recession is a contraction in a country’s gross domestic product (GDP) for six months (two consecutive quarters) or longer. In a weakened economy, consumers typically spend less money. This is bad for business, which in turn can result in higher unemployment, and less spending again – anything but a virtuous circle.

Is the UK already in recession?

The UK economy shrank by 0.2% in the third quarter of 2022 and narrowly avoided entering a recession at the end of the year when the fourth quarter numbers were flat. But to me, even if we never technically get a recession, it has felt like we’ve been in one for some time. Why? Because ever since Brexit, productivity, vacancies, and investment levels have all dropped, and the situation was made worse by Covid. Souring inflation and rising interest rates have only compounded the issues.

What does this mean for our investments?

Stock markets often move ahead of economies, therefore by the time we are in a recession, they may have already bottomed or be close to their lows. Indeed, a lot of bad news has already been priced in at this point, given the vicious sell-off markets experienced in 2022.

But there are some investments that tend to do better than others in the run up to and during a recession. Here we take a quick look at what those investments are and which funds ISA investors could consider this year:

1) Quality companies

When it comes to investing in the shares of companies, quality businesses are usually best placed to handle a recession. These will be ones with solid balance sheets (therefore not too much debt), stable profit margins, resilient revenues, and a market leading position – so they can gain market share when weaker competitors go by the wayside.

Two UK equity funds investing in quality companies that you might consider are Liontrust Special Situations and LF Montanaro UK Income.

2) Sector specific ideas

Just as some companies may do better in a recession than others, so can some sectors – for example, the healthcare sector. Pharmaceuticals is one of the more defensive subsectors in this area as demand for medicines tends to be inelastic – we need them no matter what the state of the economy. And then there is insurance. Everything around us is insured, regardless of economic boom or bust, and much of it is a legal requirement. This provides the sector with good defensive characteristics.

Polar Capital has two products in these areas which we rate very highly. They are Polar Capital Global Healthcare Trust and Polar Capital Global Insurance.

3) The year of the bond?

After a brutal 2022, there is an expectation that 2023 may well become ‘the year of the bond’. Because, while more interest rate rises and sticky inflation could hurt in the short-term, as the year pans out, the combination of good levels of income and capital gains as interest rates peak and then fall, could prove to be lucrative for bond holders. Care will need to be taken as some higher yielding companies could default if recession bites, but opportunities are certainly plentiful.

A good flexible bond fund like Aegon Strategic Bond or TwentyFour Dynamic Bond – which can pick and choose which area of fixed income they invest in – may be an option here.

4) Investing overseas

Finally, given the UK is the only major economy forecast to shrink in 2023, investors could always consider investing abroad where the climate for businesses may be more favourable. The IMF has made a slight increase to its global growth outlook for 2023, due to “surprisingly resilient” demand in the United States and Europe, easing energy costs and the reopening of China’s economy. It is now forecasting 2.9% global growth for 2023 and sees developing Asia growing by 5.3%.

Invesco Asian is an option for those looking to make the most of the fastest growing continent, or Mid Wynd International Investment Trust for investors wanting to diversify this year’s ISA allowance around the globe.

Darius McDermott is managing director of Chelsea Financial Services and FundCalibre