Is a Recession Coming: Why Should Investors Care?
Debates about whether a recession looms on the horizon have been going on for a while now.
Some have concluded that 2023 will be decidedly bleak while some are more sanguine about the state of the economy, asserting there will be slower growth but the world remains far from a recession.
Regardless of which camp you belong to, it is always better to be prepared for one.
We highlight several leading indicators, or data that changes in advance of the rest of the economy, that are often observed for signs of a possible downturn and suggest ways for you to be better prepared.
What signals a recession?
The first indicator is the yield curve inversion which occurs when the yields on short-term bonds exceed those on long-term ones.
Duration is an important concept in the fixed income space.
Under normal economic conditions, bonds with longer durations have higher yields because the risk of interest rate movements in response to economic changes is higher over a longer horizon.
Therefore, investors seek to be compensated for taking on additional risk.
The inverted yield curve implies that investors expect rate cuts in the near future to stimulate a weakening economy, thereby capping longer-term rates.
The second indicator points towards a technical recession, which occurs when gross domestic product (GDP) growth is negative for two consecutive quarters.
Other key economic indicators include a double whammy of higher unemployment and falling, but nonetheless high inflation.
Additionally, metrics that capture confidence levels such as the Business Expectations of the Manufacturing and Services Sectors in Singapore or the Small Business Optimism Index in the US provide hints about the state of the economy.
The performance of various asset classes such as the stock or bond indexes also acts as a proxy to gauge the confidence levels of market participants.
High unemployment and inflation
There are many reasons to care about a recession.
The most important reason is how a recession may impact you.
Inflation is in the spotlight now and can, at times, be a precursor to a recession.
Rampant inflation can result in wages not being able to keep up with rapidly rising expenses.
Individuals need to understand how their earning power compares against the inflation rate as this relationship directly affects consumption patterns.
For instance, lower-income families may find themselves unable to afford even the most basic necessities such as food and utilities when prices accelerate too quickly.
At the extreme, failing to plan for inflation can push people into poverty, leading to social unrest and a steep cost for governments as they tackle the problem.
As mentioned above, unemployment is also a very real threat during economic declines.
Certain industries are deemed to have a higher propensity of laying off workers during recessions, while others are naturally more resilient.
For those at risk of losing their jobs, they may consider adopting methods to reduce their chances of being retrenched and picking up useful strategies to find new jobs.
Seek alternative income sources
Apart from beefing up one’s desirability as an employee, you also want to be better prepared financially by paying off liabilities, setting aside liquid funds to finance everyday needs, and earmarking sufficient savings for retirement and emergency.
If you have spare cash after settling the above, you can consider building up an opportunity fund.
Sharp market declines may present great buying opportunities, but only if you are equipped with sufficient cash to take advantage of them.
During a weak labour market with uncertain prospects, it is important to seek alternative sources of income to tide yourself and your loved ones through.
The key is to identify investments that can hold their value so that their prices recover alongside the economy once the recession abates.
Thus, investment strategies should be centred around diversification in two forms.
The first of is diversifying your entry.
Instead of trying to time the market, consider dollar-cost averaging during bear markets to remove the emotion from your investment decisions.
The second is to diversify your holdings.
During a recession, certain sectors such as healthcare are more resilient than others such as technology.
A possible healthcare stock to consider is Johnson & Johnson (NYSE: JNJ).
Johnson & Joshnson is an American healthcare giant that fared well during the 2008 financial crisis, losing only 21% versus the S&P 500’s 54%.
More impressively, the company has a track record of paying increasing cash dividends every year since 2002, even during the period that coincided with the 2008 global recession.
Even though certain sectors are more recession-proof, investors should also plan ahead and hold stocks that best ride the recovery wave.
Examples of such sectors include consumer discretionary and real estate.
Having some geographical diversification is also advised, and buying Singapore stocks is a good way to achieve this.
Holding REITs such as CapitaLand Integrated Commercial Trust (SGX: C38U) provides investors with some real estate exposure which should do well when the economy rebounds.
At the same time, consider including certain blue-chip stocks such as Jardine Cycle & Carriage Limited (SGX: C07) that not only provide sector diversification but also pay out regular dividends.
Given that there is significant uncertainty when heading into a recession, risk management through diversification is strongly encouraged.
Get Smart: Look favourably at recessions
For all the doom and gloom surrounding a recession, investors should view such a situation as an opportunity to grow their wealth rather than fear it.
As Shelby Cullom Davis said, ‘You make most of your money in a bear market, you just don’t realise it at the time’.
Buying great companies during downturns has proven to be an effective long-term strategy; all you need is patience and tenacity.
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Disclosure: Tan Ke Xuan does not own shares in any of the companies mentioned.
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