Recessions explained

What is a recession?

A recession occurs when an economy stops growing and starts shrinking.

Many people view two consecutive quarters of negative real GDP growth (the value of goods and services produced by a country) as a recession.

However, the National Bureau of Economic Research (NBER) in the US views a recession as a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production (manufacturing), employment, real income and retail sales.

So, a recession will typically occur when we see a decline in incomes, employment, manufacturing, retail sales and GDP.

Putting recessions into perspective

Recessions are not uncommon. They are part of the broader economic cycle, and it is inevitable that we will live through a number of these in our lifetime.

In fact, the US market has been in recession 13% of the time since 1962. Each time economic growth and equity markets have recovered. Over this 60-year period, the S&P 500 Index (excluding dividends) has provided a total return of over 7,500% or 7.5% per annum.

While no-one likes to see the value of their investment fall, that is the nature of economic cycles and equity markets. Share prices go up, and down, and portfolios need to be positioned to handle this.

This starts with ensuring you have the right asset allocation for your risk tolerance. If you are not comfortable with the thought of your portfolio potentially declining 20% or more, then you should be in a more conservatively positioned portfolio with a higher allocation to cash and fixed income, and a lower exposure to equities. The higher your tolerance for risk or fluctuations in the value of your portfolio, the higher exposure you are likely to have to equities.

Focus on high quality companies with strong pricing power

A focus on high quality companies that have strong pricing power and provide essential goods or services that remain in demand throughout the cycle should be able to maintain margins and grow through recessionary periods. These companies tend to operate in the utilities, consumer staples, healthcare, telecommunications and technology (software) sectors.

Some general strategies to help your portfolio weather recessionary periods include:

• Ensure your asset allocation is right for you.
• Stay diversified. Markets and sectors recover at different speeds. This is something we have seen time and again through previous economic downturns. Investing across different markets, sectors and securities is the best /insurance policy against risk.
• Think long-term i.e. 10 years plus. If your investment horizon is shorter than this, then investing in equities may not be right for you.
• Keep investing (in instalments). Think of the downturn as an opportunity to buy great companies on sale. Regardless of whether you are buying at the bottom or if there is another leg down from here, history has shown that over time markets recover.
• Anchor portfolios in high quality companies with strong cash flows, a strong balance sheet, and sustainable earnings whose product or service is supported by long-term structural tailwinds.
• Focus on income growth rather than fluctuations in share prices.