‘Never miss out on an opportunity like a recession’ — Jack Welch, former chairman and CEO of General Electric (NYSE:GE).
In an effort to combat runaway inflation, the US Federal Reserve, along with other central banks around the world, began hiking interest rates in 2022 and has continued to do so throughout 2023. But as most economists will tell you, central banks don’t have the best track record for curbing inflation without summoning a recession.
“Since the post-war era, the vast majority of federal tightening cycles do end up in a recession. So this has to be the base case this time,” Chris Wood, head of equity strategy at Jefferies Hong Kong, said in a 2022 presentation.
Others believe the country has already entered a recession. US gross domestic product (GDP) contracted in the first two quarters of 2022, and two consecutive quarters of declining GDP is often considered the most important signal that a recession has arrived. However, American GDP has posted gains in subsequent quarters.
Aside from GDP, another key metric for measuring the health of the economy is the price of copper. The red metal is the most widely used of the base metals, from construction and electronics to electric vehicles and charging stations. Its price activity has been volatile in 2023, and as of late August copper prices were down by 10 percent from the start of the year.
Despite these and other factors, some are reluctant to even say the word ‘recession.’ In late June, US President Joe Biden said he doesn’t expect a recession in the near term — in fact, he believes the US economy is strong. In August, ABC News noted that the word “recession” was not even mentioned in the first Republican presidential debate.
So — are we in a recession? Even though nailing down an answer is tricky, investors can get educated on what a recession is, how long they last and what strategies may work well during these difficult economic periods.
What is a recession?
When a country’s economic activity experiences a serious and persistent decline over an extended period, often over two consecutive quarters, economists call it a recession. Some of the key indicators of a recession include rising unemployment levels, negative GDP, stock market selloffs and falling manufacturing data, as well as declining consumer confidence as evidenced by dropping retail sales. Recessions involve a broad array of economic sectors, not just a decline among one or two industries.
Answering the question, ‘Are we in a recession?’ is difficult because so many factors are at play — while one expert might weigh GDP declines heavily, another might feel other elements are more important.
Watch the video below to get a sense of why getting a consensus can be tough.
Experts Rick Rule, Adrian Day and Mike Larson explain why it’s hard to get an answer on whether the US is in a recession.
What causes a recession?
Forbes lists a number of catalysts that can spark a recession: sudden economic shock, excessive debt (think the US mortgage debt crisis that fueled the Great Recession in 2008), asset bubbles, uncontrolled inflation (which leads central banks to raise interest rates, making it more expensive to do business or pay down debts), runaway deflation and technological changes.
Are there signs before a recession?
What are the telltale signs that warn of a recession in advance? Much like the weather, making any sort of economic forecast is difficult. But there are certain signals economists look out for.
Aside from the previously mentioned slumping GDP and falling copper prices, declining unemployment figures, shrinking industrial output and falling retail sales are classic indicators of a potential recession.
Another harbinger of a looming recession is an inverted bond yield curve. “The bond market can help predict the direction of the economy and can be useful in crafting your investment strategy,” Investopedia states. “This metric — while not a guarantee of future economic behavior — has a strong track record.”
How long do recessions last?
Recessions are considered a part of the normal expansions and contractions of the business cycle. While not as catastrophic as depressions, recessions can last for several months and even years, with significant consequences for governments, companies, workers and investors. Each of the four global recessions since World War II lasted about one year.
That said, there have been a few short-lived recessions in the US, including the 2020 pandemic recession. Stock markets around the world crashed at the onset of the COVID-19 outbreak. A record 20.5 million jobs were lost in the US alone in April 2020 as the nation’s unemployment rate reached 14.7 percent.
The Fed responded by cutting interest rates, and the US federal government issued trillions of dollars in financial aid to laid-off workers and impacted businesses. By October 2020, US GDP was up 33.1 percent, marking an end to the recession.
What sectors are hardest hit by a recession?
Businesses often tighten their belts during recessions by postponing expansion plans, reducing worker hours and benefits or laying off employees. Those same workers are the consumers who play a vital role in the strength of a nation’s economic activity.
With less disposable income, consumers stop spending on large appliances, vehicles, new homes, evenings out and vacations. The focus shifts to low-priced necessities, food and medical needs. Declining consumer spending and demand for goods and services pushes the economy into a deeper recession, resulting in more layoffs and rising unemployment. Small- and medium-sized business owners may even find themselves unable to operate entirely.
Typically, retail, manufacturing, restaurants, technology, travel and entertainment are hit the hardest during a recession. The real estate and mortgage lending sectors may also feel the pain.
As the recession worsens, some homeowners may not be able to pay their mortgages and could face defaults, which can bring further downward pressure on real estate prices. Those still shopping for a home or new car may find that banks have instituted much tighter lending policies on mortgages and car loans. Meanwhile, investors can lose money as their stock holdings and real estate assets lose their value. Retirement savings accounts linked to the stock market can also suffer.
All of these forces can contribute to a deflationary environment that leads central banks to cut interest rates in an effort to stimulate the economy out of a recession.
How to prepare for a recession?
There is no perfect answer for how to invest during a recession, and no stock remains recession-proof. But for those who know how to practice due diligence through fundamental analysis, recessions do offer an opportunity to pick quality stocks at a discount.
“The stock market is the only store where when things go on sale, everyone runs out the door. You don’t want to be one of those people,” said Shawn Cruz, head trading strategist at TD Ameritrade. “So if you have a long term focus and some specific names you’re looking at, this is a good time to pick up some quality shares for your portfolio.”
It’s better to look at well-established publicly traded companies with strong balance sheets and minimal debt that still have the ability to generate cash and pay dividends. Companies to avoid include those with high debt loads and little cashflow, as they have a difficult time managing operating costs and debt payments during recessions.
Industry matters, too. As mentioned, real estate, retail, manufacturing, restaurants, technology, travel and entertainment are hit the hardest during a recession. On the other hand, stocks in the consumer staples (food and beverage, household goods, alcohol and tobacco) and healthcare (biotech and pharmaceutical) sectors tend to do well in recessionary environments.
Inventors can further mitigate the risks that a recession brings by building a diversified portfolio that considers stocks across varying sectors and geographic regions. Rather than investing in individual stocks, exchange-traded funds with low management fees are another way to spread risk. The Vanguard Consumer Staples ETF (ARCA:VDC) and the Consumer Staples Select Sector SPDR Fund (ARCA:XLP) are two examples to consider.
Should I wait to invest until after a recession?
This question brings us back to the quote from General Electric’s Welch that’s cited at the beginning of this article. For long-term investors who understand the popular adage, “buy low, sell high,” a recession and its impact on share prices offers up those ‘buy low’ opportunities. That’s because all things come to an end, even recessions, and when that happens those who bought the dip will be well positioned to benefit from the rebound.
That said, due diligence never goes out of style. Not all companies will make it through a market downturn unscathed. To truly see returns from this investment strategy it’s critical to look for companies with strong balance sheets, experienced management and a history of performing well in bear markets. Opting for revenue-generating and dividend-paying stocks over growth stocks during a recession is another smart play.
Overall, experts advise that it’s not necessary to avoid investing during a recession. “While (recessions) can be challenging for returns and growing wealth, we also see countercyclical rallies and the market is always forward-looking, so the keys are to remain fully invested, not be whipsawed by short-term market gyrations and to keep (focused) on your long-term goals,” Rajesh Nakadi, head of investments, Global Family Office at BNY Mellon Wealth Management, told Forbes.
What assets can hold their value in a deep recession?
For long-term investors looking to ride out the worst recessions, stocks and high-yield bonds are best avoided. Safer assets that have historically performed well during recessions include government bonds, managed futures, gold and cash.
If you’ve parked your dollars in actual dollars, i.e. cash, instead of the stock market, the value is not being erased by declining stock prices. The ‘cash is king’ mantra speaks to the importance of keeping liquid assets on hand during a recession.
Along that same vein, gold has earned its safe-haven status because it is a physical asset that holds its value and can be easily liquidated. “People want to hold a physical commodity that has inherent value and can hold that value when equities decline,” said Ed Egilinsky, head of alternative assets at New York-based exchange-traded fund and mutual fund company Direxion Investments.
One last thought — don’t move all your wealth into gold or cash. A diversified portfolio is still the best hedge against a recession.
Which stocks do well after a recession?
Once the economy is in the recovery stage and consumer confidence begins to improve, the best performing stocks in the market tend to be tied to the technology, financial, consumer discretionary, industrial, material and energy sectors.
The consumer discretionary (i.e. cars and appliances), material and industrial segments “are known as cyclicals, because they are closely tied to the fortunes of the economy,” states RBC (TSX:RY,NYSE:RY). The bank explains that once demand improves, manufacturers will begin using up their inventory and will in turn “need to order metal, chemicals and other materials to create more goods to sell.”
FAQs about a potential recession
Will there be a recession in 2023 or 2024?
Forecasting recessions can be tricky. While many historical recession signals are currently flashing red, there are extenuating circumstances that make a deep recession less likely than in times past.
One of those is the relatively low unemployment rate in the US. “It’s difficult to have a recession with a situation where everybody’s working and getting paid more,’ said Marc Lichtenfeld, chief income strategist at the Oxford Club.
A July Bankrate survey of economic experts places the odds of a recession by July 2024 at 59 percent. That’s down from the 64 percent chance of a recession by the end of 2023 forecast in the firm’s previous quarterly survey. “Economists’ recession odds suggest a downturn is more probable than not, but those recession odds have also fallen, with the most recent odds hitting the lowest since the second quarter of 2022 survey,” notes Bankrate.
Is Warren Buffett predicting a recession?
Warren Buffett is not known for his direct forecasts. In fact, he’s likely to say, “Nothing is sure tomorrow, nothing is sure next year and nothing is ever sure, either in markets or in business forecasts, or in anything else.” For that reason, his investment decisions are often read like tea leaves by market watchers looking for signs on where to invest.
So when the Oracle of Omaha strikes a somber tone on the economy, it’s not a good sign. Speaking to shareholders at Berkshire Hathaway’s (NYSE:BRK.A,NYSE:BRK.B) annual meeting in May, Buffett proclaimed “a different climate” for business as demand begins to cool. He noted that inventories are building up for many of the firm’s subsidiaries, and not even sale stickers are moving products. This will likely lead to lower earnings this year for these subsidiaries, he warned.
Another move by Buffett that’s being interpreted as a recession signal? Berkshire Hathaway’s decision to sell off of US$8 billion in stock in the second quarter to beef up its cash holdings.
What does Michael Burry say about the recession?
“Big Short” investor Michael Burry has been calling for a recession since early 2023. More recently, he put his money where his mouth is by betting nearly 90 percent of his portfolio on the possibility of a recession on the horizon.
“Burry’s fund, Scion Asset Management, bought $866 million in put options (that’s the right to sell an asset at a particular price) against a fund that tracks the S&P 500 and $739 million in put options against a fund that tracks the Nasdaq 100,” CNN Business reported in mid-August.
Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.