Recession

What is a recession?

A recession is when gross domestic product (GDP) shrinks for two consecutive quarters. It’s a measure of the overall size and health of a country’s economy over a period of time.

The less technical term for a recession is a large decline in economic activity that lasts for months or even years. Essentially, when a country’s economy is shrinking.

What happens during a recession?

By definition, a recession is where GDP declines over a six-month timeframe. So, to understand what happens in a recession, it’s best to understand why we’d typically see a decline in GDP.

GDP is measured by the total value of goods and services produced. If GDP starts to move on a downward path, it’s ultimately down to the fact consumers, businesses and governments aren’t spending as much. There can be a number of reasons for this. A weak economic outlook and the threat of a recession is usually the catalyst for this.

Economic uncertainty means consumers are more cost conscious and less confident about splashing their cash. Both businesses and shareholders feel the pinch in the form of lower profits and government has less income from taxes. All the above contribute towards a change in the economic cycle and a shrinking economy – things such as job losses and tax hikes can be expected.

What causes a recession?

All recessions can have different causes and effects. The route an economy takes before entering a recession is often varies.

Here are some common causes of a recession:

• A financial crisis – a lack of liquidity from banks during the financial crisis in 2008 led to reduced lending and investment. This resulted in one of the biggest recessions in history.
• Rising interest rates – increasing the cost of borrowing lowers overall investment and spending activity in the economy.
• Declining stock market – falling asset prices reducing people’s wealth and leads to reduced spending.
• Fall in consumer and business confidence – low confidence can make consumers and businesses think twice before making that next purchase, impacting GDP growth.
• Supply issues – increases to commodities prices, such as oil and gas, cause inflation to rise and reduces people’s spending power.
• Black swan event – unexpected events that are almost impossible to predict, but eventually happen at some point. For example, the COVID-19 crisis.

Which indicators are warning of recession?

A recession comes at the bottom of the so-called economic cycle. Where we are on that cycle is determined by a set of leading (advance warnings of future movements in the economic cycle), and lagging (changes we see once the economy has already shifted) indicators.

One of the key leading indicators is the stock market. It’s also one that tends to get a lot of attention. Share prices reflect predictions of a company’s future profits. So, all else being equal, healthy share prices suggest positive expectations for the future.

On the flipside, a downward market trajectory suggests companies are expected to have a more difficult time. This can be an indicator the economy is heading towards the contraction phase.

However, the jury is still out on whether this traditional indicator is truly signaling a potential recession.

Is the UK in a recession?

At the time of writing (March 2023), the UK isn’t in a recession but a shallow recession is still widely expected.

The cost-of-living crisis and the impact of the Russia-Ukraine war has lead to many economists and forecasts predicting a recession could be on the table.

The last time the UK went into recession was in 2020 at the height of the COVID-19 pandemic.

There are a few things to consider when spotting a recession.

GDP is a lagging indictor, so it isn’t reflective of the economy’s current state-of-play as it takes a couple of months for the figures to be calculated and reported on.

Additionally, a technical recession requires GDP to decline for two consecutive quarters. So, a country’s economy could experience a small period of growth in some months, but still be in a decline for the overall quarter.

How long do recessions last?

No two recessions are the same, so past recessions aren’t a guide to future ones.

The last recession the UK experienced in 2020 lasted for six months. Though, this was related to the pandemic which was a unique set of circumstances.

The one before that was the financial crisis in 2008 where it lasted for around five quarters (15 months).

How to invest during a recession

We always say investors should invest with the long term in mind. This has proven to be a far more successful strategy than trying to time the market (trying to catch share prices on the upswing and then selling when prices fall).

To invest successfully for the long term, investors need to make sure they hold a diverse mixture of different types of investments. Having too much invested in one region, sector or type of investment can mean your whole portfolio is subject to the same risks.

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It could also be time to consider quality companies or funds with an investment style bias towards them. These are the kind of companies that offer indispensable products or services. The kind of thing customers will keep paying for regardless of how well the economy’s doing. These companies often have more pricing power and won’t feel as much of a pinch if conditions take a sharp downwards turn.

Remember, their value still can go down as well as up, so you could make a loss and past performance is not a guide to the future. That’s especially important in the current uncertainty.