In 2022 and 2023 the US Federal Reserve hiked interest rates from 0.25% to 5.5%, to tackle the soaring inflation caused by the COVID-19 pandemic.
Investors feared a recession.
But growth proved robust and inflation headed back down towards target levels – a positive backdrop for stock investors. This allowed the central bank to cut rates. And when Trump won the election, business leaders’ confidence rose in anticipation of pro-business policies.
GDP fell 0.3% in the first quarter of 2025. But, this was largely due to the negative contribution from trade, with buyers of foreign goods front-running the tariff increases. Final sales to private domestic purchasers is arguably a better measure of underlying growth and this grew 3%.
Then came Trump’s tariff storm
This all changed on 2 April with the announcement of President Trump’s ‘Liberation Day’ tariffs.
The many twists and turns in tariff policy since has had a negative impact on the economic outlook, with surveys of consumer and business confidence plunging.
Economists have also revised down their forecasts for US and global economic growth.
A Bloomberg survey of economists puts 40% odds on a US recession in the next 12 months. Markets say 70%.
This article isn’t personal advice. Investments can rise and fall in value so you could get back less than you invest. If you’re not sure if an investment is right for you, ask for financial advice. Remember, past performance isn’t a guide to the future.
So, will we get a recession or not?
If the odds of a recession are close to the toss of a coin, what will decide which way we fall?
We see two possible scenarios on tariffs.
If tariffs are implemented as currently set out – or increased further – then the odds of a US recession increase.
However, if the US reaches bilateral deals to lower tariffs with a range of countries, then the odds reduce.
The adverse reaction of markets could also lead to a policy U-turn.
The US stock market, government bond prices and the dollar all fell immediately after tariffs were announced. And we’ve seen signs of pragmatism, like introducing a 90-day pause and softening of tariffs on cars after lobbying by the industry.
Hard and soft data – what should investors be looking out for?
What data are we watching to judge whether the economy is set to shrink?
The data that really matters is the hard data like GDP growth and unemployment data.
However, this is issued with a time lag measured in weeks or months.
And because the definition of a recession is two consecutive quarters of contraction, it means they’re typically not confirmed for around seven months after they start.
We also monitor soft data, like confidence surveys and business investment intensions, to give us a feel for where things are heading. These aren’t entirely reliable, but they provide investors with a more up-to-date indicator of activity.
Investors can also look at daily and weekly data to judge what’s going on, such as daily debit card spending, restaurant bookings, and weekly retail sales.
The impact of cyclical, structural and shock recessions
The impact of a recession on investments depends on the cause of the downturn.
In Any Happy Returns, Goldman Sachs’ strategist Peter Oppenheimer studies three different types of bear markets.
It’s natural for economies to go through cycles – booms and busts.
In a typical four-stage cycle, an economy will go from a recession to recovery, to expansion, to overheating before falling into recession again.
In the UK, these cycles have lasted around eight years on average over the last 200 years.
Occasionally, structural imbalances build up in economies leading to a deeper, longer decline. The Great Depression of the 1930s, the inflation shock of the 1970s and the Global Financial Crisis of 2007-2009 are the prime examples.
Recessions can also be triggered by shocks – such as when the global economy ground to a halt due to pandemic-led lockdowns.
For stock investors, recessions due to structural imbalances are particularly painful, with declines lasting three and a half years on average.
Cyclical bear markets typically last over two years.
By contrast, downturns from event-driven shocks typically last around eight months and recover within just over a year.
What do recessions mean for stock markets?
When economic growth slows down, so too does growth in companies’ sales and earnings – bad news for most stock investors.
Lower corporate earnings are also bad news for holders of corporate bonds as they increase the risk of default.
Recessions typically lead to higher unemployment, putting downward pressure on wages – and therefore inflation.
This is good news for holders of government bonds.
Today, however, the outlook for inflation is clouded by the tariff story since these are expected to boost prices in the US.
In general, investments perceived as ‘safer’ tend to outperform more risky investments. Companies with more predictable earnings, like healthcare stocks, have tended to hold up better than businesses more exposed to the economic downturn, like consumer discretionary stocks.
How to invest during a recession
The key lesson to remember is every recession is followed by a recovery.
Timing the top and bottom is impossible – we only know with hindsight when a recession starts and ends. And, with investors already putting high odds on an upcoming recession, some of the bad news has already been factored into prices.
It’s usually best to stick with your investment strategy during a recession and to think with the long term in mind.
However, it can also make it a good time to check in on your investments and make sure you’re happy with your portfolio and how much risk you’re taking.
If you want to reduce the vulnerability of your portfolio to downturns, think about diversifying in different asset classes, sectors and countries.
You could also consider investing regularly through a direct debit – this way you can benefit from pound-cost averaging.
Pound-cost averaging is a powerful way to help smooth out the ups and downs of the market.
When you invest monthly, you buy more units or shares in an investment at lower prices if the value falls, helping you achieve better returns. However, if investment prices continue to rise, you’ll buy fewer units or shares at higher prices.
By investing at many different times, you avoid the risk of investing all your money when the market is at its highest. You should still regularly review your investments to be sure they’re right for your objectives and attitude to risk.
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