Investing in a recession: 5 things investors need to know

Investing in a recession: 5 things investors need to know

AJ Bell press comment – 22 November 2022

  • OECD joins OBR and Bank of England with a grim forecast for the UK economy
  • A lower peak in interest rates may help economic performance
  • What investors should be doing with their portfolio in the face of an economic slowdown

Laith Khalaf, head of investment analysis at AJ Bell, looks at some of thethings investors should be considering with their portfolios as the UK enters an economic downturn:

“The OECD is the latest economic forecaster to predict grim times ahead for the UK, with the economy projected to be the worst performer in the G20 over the next two years except for Russia, a country which is suffering from a wide range of international sanctions. Indeed, the UK may already have entered a recession, with the economy slipping backwards by 0.2% in the third quarter of the year, according to the Office for National Statistics. The Bank of England and the OBR are also now forecasting a prolonged period of weak or negative economic growth stretching through 2023 and into 2024, though it must be said their estimates are built on market expectations for interest rate hikes. The Bank’s interest rate setting committee has signalled it thinks the market is pricing in too many rate rises, and if they are right and interest rates peak at a lower level than currently anticipated, the economy may actually do better than the economic models suggest.

“Whatever the precise figures turn out to be, it seems clear we are entering a period of weak economic conditions in the UK, and many investors will be wondering what they should be doing with their investments in response. If your portfolio is already in good shape, the answer is probably very little. But if your portfolio has been lacking some attention of late, and has grown muddled and ragged as a result, there are some concrete steps you can take to pull it back into good order. The basic principles of portfolio management become even more important in an economic downturn and so spending a bit of time getting these right will improve your resilience to recessionary forces.”

1. Spread those eggs

“Having a balanced and diversified portfolio is always important but takes on even greater significance when times are tough. Economic hardship puts pressure on businesses all across the market spectrum and you never know precisely where the cracks are going to appear, so you shouldn’t have too much in any one stock, fund, industry or region. You should also keep your portfolio manageable in terms of the number of funds and stocks you hold, so you can give each one the appropriate attention. Otherwise you won’t have time to fully digest news like profit warnings or assess manager performance.”

2. Be vigilant but not a vigilante

“You should regularly review your portfolio, but don’t let this lead to over-trading. When markets are volatile and losses are mounting, you might be drawn into doing something just to try and exert some sort of control. It’s incredibly tempting to be a portfolio vigilante and take matters into your own hands, distributing some natural justice by petulantly dispensing with investments that have fallen in value. But you should resist that temptation and only make changes based on reasoned considerations rather than on a gut reaction. Think Buffett not Batman. By constantly tinkering you’re likely to end up making mistakes, and racking up trading costs too.”

3. Take the easy wins

“When times are tough you should also ensure that you bank the easy wins. That means making sure your portfolio is invested as tax efficiently as possible using SIPPs and ISAs, and ensuring that you’re keeping charges under wraps too. The annual benefits that are yielded by these simple steps might seem small, but they will compound your returns year in year out, and lead to a bigger nest egg when you come to draw on it. This is especially important given the raft of tax rises we are seeing on earned income, capital gains and dividends over the next few years.”

4. Don’t ignore dividends

“Investors should also pay due attention to dividends. When growth is thin on the ground, dividends can keep your investment scoreboard ticking over. Poor economic conditions aren’t great for profits and hence dividends, but many companies used the shock of the pandemic to cut their regular shareholder payouts and reset them to much more affordable levels. Dividend cover for the FTSE 100 currently sits at 2.36, according to the AJ Bell Dividend Dashboard, the highest level in a decade. That means company profits are more than double the amount of dividends being distributed, giving companies a large buffer before they need to start thinking about cutting back again.”

5. Think two steps ahead

“It’s extremely important to recognise that an expectation of future economic conditions is already baked into share prices. Companies which are heavily exposed to under-pressure consumers such as retailers and travel stocks have already seen sharp falls this year, while defensive stocks like tobacco companies have had a much better ride. The market is always looking ahead and though it might sound strange, now is probably a good time for investors to be anticipating better economic climes, rather than fretting about the current malaise. That doesn’t mean betting the whole farm on recovery, but it might be a good time to start thinking about drip feeding money into the market, ideally through a regular investment plan in recognition of the fact that the global market may yet have further to fall.

“While the UK recession is forecast to be long, it’s also expected to be shallow, so companies will be trading into an economy that is going down a slight slope rather than plunging off the edge of a cliff. That still gives good companies the ability to grow. Investors should also take note that their investments are likely only partly in thrall to the UK economy, with many funds and indeed companies on the London Stock Exchange deriving lots of their earnings from overseas. Economic growth in the US and the Euro area isn’t looking particularly rosy either, though they are forecast to do better than the UK next year, according to OECD projections.

“Recessions are part and parcel of the normal economic cycle and if you’re investing for the long term, you have to expect to encounter them. While this can be painful for your portfolio, the upswing in share prices when recovery comes knocking can be swift and powerful, and if you’re not invested when this happens you could be taking the rough without the smooth.”

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