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What investors need to know about the threat of recession

We look at why a recession could be round the corner and what investors can do about it.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

The media is jam-packed with warnings of a recession being round the corner. But is this a fair assessment?

Here’s a closer look at what a recession is, what could be next, and what investors can do about it.

This article isn’t personal advice. If you're not sure if an investment is right for your circumstances, seek advice. All investments and any income they produce can fall as well as rise in value, so you could get back less than you invest. Past performance is not a guide to the future.

What is a recession?

The ‘technical’ definition of a recession is when GDP shrinks for two consecutive quarters. GDP stands for Gross Domestic Product. It’s a measure of the size and health of a country’s economy, over a period of time. 

However, the more general term for a recession is a significant decline in economic activity that lasts for months or even years.

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 headed towards the contraction phase.

Global markets have had a difficult year so far. The US stock market is down around 20% year-to-date, while the UK market has had its wings clipped to the tune of 8%. Contrary to what some people think, a downbeat market doesn’t mean recession has arrived. The market and the economy are very different beasts. Instead, current market moves suggest predictions for future corporate earnings are weaker.

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

Some commentators are quick to point out that companies are in a stronger position than the market’s suggesting. By some estimates, companies are in a good position to pass on surging input costs to consumers, and expectations for operating margins are high by historical standards.

By assuming this, these analysts are essentially saying the consumer base is more resilient than feared, and able to stomach higher prices.

The other side to the argument is that current market jitters are indeed warranted.

As inflation surges and the energy crisis shows no signs of abating, it’s unlikely customers are going to continue swallowing rising prices. This, alongside rising interest rates, is why analysts’ earnings downgrades are expected to accelerate. Unfortunately, we think this more downbeat scenario is more accurate.

How are people feeling?

Consumer confidence is another important thing to consider – there’s plenty of room for feelings as well as facts and figures when trying to work out the economy’s next move.

Looking at consumer confidence only, we’re already in recession territory. People are nervous about what soaring inflation means for them. What’s interesting is this concern can become a self-fulfilling prophecy. That’s because pre-emptive purse-string tightening can trigger recessionary activity in the economy.

Didn’t the UK economy grow more than expected recently?

Yes. GDP rose by 0.5% in May – the latest data we have. That defied expectations that the economy would remain stagnant.

Growth was driven by areas including construction and health services – it appears a surge in GP visits helped prop up the wider services sector. Manufacturing also put in a resilient performance.

It’s of course positive to see this unexpected nudge upwards in overall GDP. But progress has hardly shot the lights out.

It will take something strong to fully reverse fears the UK’s heading towards a recession in the coming year. Until there’s a clear path out from political turmoil, the energy crisis, cost-of-living squeeze and the UK’s far-reaching productivity problems, it’s hard to see where the economy will find its take-off point.

What should investors do?

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.

Learn more about diversification 

It could also be time to consider quality companies. 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 and past performance is not a guide to the future. That’s especially important in the current uncertainty.

How to find quality companies – 3 share ideas

Key takeaways

While the UK’s economic condition has been a bit better than feared lately, a recession is likely on the way. The exact timing is hard to predict, but we think it will likely be within the next year.

Investors need to remember, the stock market and the economy are very different. The market has often acted as a canary in the coal mine, rather than being an indication of what’s already happened.

It can be easy to bury your head in the sand and ignore your investments when markets feel unpredictable. But for those prepared to take stock of their investments and think with the long term in mind, uncertain times are often when you can find the most opportunity for those happy with the risks, although of course there are no guarantees.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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