Navigating economic uncertainty

The widespread discussion of the term ‘recession’ in news headlines is hard to overlook. But what exactly constitutes a recession, and how does it affect you and your investments?

Global financial markets are witnessing a wave of risk aversion, intensifying dynamics that had already begun to emerge late last week when disappointing US economic data sparked fears of a recession in the world's largest economy.

Although predicting the exact timing of a recession is difficult, you can prepare by maintaining a disciplined investment approach, helping you stay on track to achieve your long-term financial goals.

In this article we explore the nature of recessions, their causes, and strategies for managing your investments during economic uncertainty.

Understanding economic recessions

A recession is a significant decline in economic activity that lasts for an extended period, typically visible in various economic indicators such as GDP (Gross Domestic Product), real income, employment, industrial production, and wholesale-retail sales. A common rule of thumb is that a recession occurs when there are two consecutive quarters of negative GDP growth. Recessions can have widespread effects, on the economy and people’s lives, including higher unemployment rates, reduced consumer spending, and lower business investment

While recessions can be triggered by a variety of factors such as financial crises, high inflation, or significant drops in consumer confidence, the severity and duration of each recession can vary greatly. 

• The early 1980s recession was a severe economic recession that affected much of the world between the start of 1980 and 1982. It was caused by tight monetary policy to fight high inflation percentages worldwide. In the UK this meant inflation was about 10% and some 1.5 million people were unemployed. 
• The 2008 housing crisis stemmed from the US housing bubble bursting due to sub-prime lending in the US banking sectors. 
• The Covid-19 pandemic caused a recession in 2020. The pandemic-induced recession emerged as one of the most profound since the Great Depression. During the recession, there were multiple severe daily drops in the global stock market, the largest drop was on 16 March, nicknamed 'Black Monday II' of 12–13% in most global markets.

Economy and stock market dynamics

Contrary to widespread belief, the stock market and the economy do not always move in tandem. Economic indicators like GDP provide insights into past performance, whereas the stock market reflects investors’ future expectations.

Many investors confuse the stock market with the economy, assuming a direct correlation between them. However, their relationship is much more complex.

Take 2020 as an example: even though the global GDP declined due to COVID-19, the financial markets did not follow the same trend and actually performed quite well by the end of the year.

Markets have consistently rebounded after periods of recession

Historically, recessions tend to last around 11 months on average, with economies typically rebounding to pre-recession levels within a year after hitting their lowest point. Despite the short-term volatility that recessions can cause, the economy generally continues to grow over time. It’s crucial to keep a long-term perspective and stay focused on your financial goals during these periods.

Is a recession cause for concern?

The economy is cyclical, characterised by fluctuating periods of growth and decline. Economic expansion naturally follows periods of recession and contraction. The key takeaway is that recessions are a normal part of the economic cycle.

This graph represents the economic cycle, highlighting the variations in real GDP over time. It shows alternating phases of growth and decline, The dashed line, representing the long-term trend of real GDP, indicates that despite these short-term fluctuations, the economy generally experiences growth over time.

Navigating your investments through a recession

A diversified investment portfolio offers a defence against the unpredictability of recessions. Here are some investment strategies that can help you navigate challenging times. 

• Prepare for the unexpected: Keep savings in low-risk, easily accessible investments to provide a financial shield during economic downturns. 
• Review your asset allocation: Ensure your portfolio has a balanced mix of stocks, bonds, and other assets that align with your risk tolerance, investment goals, and time frame. 
• Diversify your investments: Spread your investments across different sectors and countries to potentially benefit from growth in areas less affected by a recession. 
• Remain calm and keep investing: Remember that recessions are temporary. Avoid making emotional investment decisions and stay focused on your long-term goals.

Crowe Financial Planning create financial plans that are aimed at growing your investments over the long term. These plans are flexible enough to adapt to changing market conditions. You can have peace of mind knowing that our recommended Fund Managers continuously monitor your investments and actively manage them to capitalise on emerging growth opportunities, to keep you on track towards meeting your goals.