Dubai: People saw their investments lose 30 per cent or more of their values during the financial crisis of 2008 and the great recession that followed. Even though there have been ensuing threats of more such recessions worldwide, they haven’t played out as bad as it’s often made out to be.
Now, a similar new risk has risen again. New polls of global economists, conducted by media giants like Bloomberg, the Wall Street Journal, and investment bank Goldman Sachs, pegged the chance of a recession in 2023 at between 60 per cent and 70 per cent. But is there cause for real concern?
“The current risk of a global recession can be alarming to any investor, especially when it comes to what needs to be done when it comes to his or her investments,” said Brody Dunn, an investment manager at a UAE-based asset advisory firm.
“However, as investors often end up regretting when they take panic-driven investment decisions, any move should be made cautiously. Historically, those who hold on to their investments through recessions see their portfolios completely recover, and those who don't invest at all lose out.”
The current risk of a global recession can be alarming to any investor, especially when it comes to what needs to be done when it comes to his or her investments
How stock markets worldwide react to the threat of recession
So while stock markets worldwide usually tank — or at the very least, becomes extremely volatile — during a global economic downturn, financial experts advise investors to not to pull money out of an investment in a moment of panic. But that doesn’t mean the threat shouldn’t be taken seriously.
“During a recession, you can expect stock prices to fall across the board. This happens for a number of reasons. For one, confidence to spend plummets during global economic downturns. People are less likely to spend money – which means businesses make less profit,” added Dunn.
“Given that the average stock market slide during a global recession is 44 per cent, as indicated by data, it’s a common saying among stock market researchers that the market would have to slide at least 30 per cent from recent highs to show that investors are taking a recession seriously.”
However, some stock market sectors, like health care and household staples, generally perform better than others in a recession. Large cap stocks also tend to hold up relatively well during downturns. So investing with such exposure can help reduce recession risk through diversification.
With the ‘FANG+ index’, which currently consists of 10 highly-traded growth stocks of popular technology and tech-enabled companies, now up 43 per cent so far this year, that leaves many parts of the sector looking expensive, according to analysts at world's largest wealth manager UBS Global.
But does this mean that recession can hurt technology stocks, because of which you should sell them to avoid losses? No. This is primarily because technology stocks are also those that can outlast a crisis and recovery quicker than other stocks.
“While we least prefer tech [stocks], we are not recommending investors to aggressively sell down exposure to the sector,” Mark Haefele, Chief Investment Officer (CIO) at UBS Global Wealth Management, wrote in a research note this week.
How diversifying your investments can help reduce recession risk
Diversification is an investment management strategy that blends different investments in a single portfolio. The idea behind diversification is that a variety of investments will yield a higher return. It also suggests that investors will face lower risk by investing in different vehicles.
It all boils down to how your investments are divided within your portfolio. When you have many years before you retire, you can afford to allocate a larger portion of your portfolio to stocks. The logic is that even if the market crashes, your investments have enough time to bounce back.
However, if you're closer to retirement age, check if you're investing too aggressively. If the majority of your portfolio is allocated toward stocks and the market sinks, you won't have much time to wait for prices to recover before you retire and begin to sell assets to help cover your expenses.
To get an estimate, subtract your age from 110. The result is the percentage of your portfolio that can be invested in stocks. The rest should be invested in relatively safe assets like bonds or gold. So if you're 65, you can invest 45 per cent of your portfolio in stocks and 55 per cent in bonds or gold.
What should be your strategy to recession-proof your investments?
According to Zubair Shakeel, another UAE-based asset manager, here are a couple of safe bets you can implement to your investment portfolio if you choose to act on your recessionary fears:
1. Get rid of risky stock investments first
While some follow general sentiment and sell investments, smart investors start by selling risky investment positions, like those stocks with a history of volatility, and those with new business models.
Instead of selling everything, top investors just sell the risky investments in their portfolios while holding onto stable investments in firmly established companies, such as blue-chip companies.
2. Shop for fixed-income investments
Investors often move their funds into fixed-income investments when the markets look unstable. Fixed-income investments mostly include bonds.
Bond prices tend to move inversely to the stock market, so when stock prices fall, bond prices rise. In the event of a large market downturn, bond prices may fall along with stocks, although their yields should increase in turn.
While maintaining a large allocation to cash is not a good long-term strategy for most investors, cash held in deposits and bonds has historically provided a cushion against market downturns during recessions worldwide
“While maintaining a large allocation to cash is not a good long-term strategy for most investors, cash held in deposits and bonds has historically provided a cushion against market downturns during recessions worldwide,” added Dunn.
“But that does not mean fears of a global recession should drive you fully away from stocks. In a recession, stock markets will likely fall further, but it will recover eventually. By investing during the low points, you'll be in a perfect position to take advantage of the upswing.”
To help manage the anxiety and fear that may arise from watching the global market and economy as they move toward recessions, veteran investors reiterate that it's helpful to have a long-term plan when allocating your savings towards your investments.
With an appropriate asset mix of stocks, bonds, and cash that aligns with your goals, time horizon, and your ability to manage risk, you can avoid overreactions to volatility and can stay on track toward your long-term financial goals.