With inflation up, the stock market down and gross domestic product (GDP) in the red, experts are debating whether the U.S. has entered a recession.
While the jury is still out on that question, you may wonder what you can do now to best position your investments to cope with stormy economic weather. Here’s what you need to know about how to invest during a recession.
Is the U.S. in a Recession Yet?
The U.S. has not officially entered a recession as of yet.
The National Bureau of Economic Research (NBER), an independent nonprofit responsible for determining the beginning and end points of U.S. recessions, waits to make a declaration until sufficient data is available.
NBER defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” Exceptions are made for extreme events, such as the sharp decline in economic activity in February 2020 that led to the intense, if short-lived, Covid-19 recession.
Read More: Are We in a Recession Yet?
One common indicator of recession is two consecutive quarters of negative GDP. The U.S. met this criterion in the first half of 2022—there was -1.6% GDP growth in the first quarter and -0.6% growth in the second—but it’s important to remember that this fact alone does not mean the nation is in a recession.
“The declines in GDP were caused by supply-chain disruptions,” says Brian Katz, chief investment officer at The Colony Group. “Inventory adjustments and net trade were responsible for most of the negative growth.”
NBER’s basic definition of a recession also requires a “significant” decline in economic activity, which Michelle Griffith, wealth advisor at Citi Global Wealth, says is not the case yet.
But this story could change in 2023.
“We are watching closely to see if the Federal Reserve rate hikes from earlier this year begin to reduce demand too quickly, which could cause a recession in 2023,” Katz says.
Rajesh Nakadi, head of investments, Global Family Office at BNY Mellon Wealth Management, believes there is a “greater than even that the U.S. will be in a recession in 2023.”
What Will the Next Recession Look Like?
Even if a recession does occur soon, Katz says it won’t look like the Great Recession or the dot-com bust of the late 1990s.
Major economic imbalances exacerbated those two recessions, he says. The dot-com recession was caused by “malinvestment in the technology sector,” and a major housing bubble spurred the Great Recession.
Read More: How Long Do Recessions Last?
“We don’t see those same types of imbalances in existence today,” Katz says.
If 2023 does bring a recession, he believes investors can expect it to be less impactful on markets than previous recessions.
How to Invest During a Recession
Investors must plan when structuring their portfolios, even if the next recession is mild.
Cash Is King During a Recession
“In economic downturns, cash is king,” says Michelle Griffith, wealth advisor at Citi Global Wealth. As companies cut back and job losses mount, “it’s better to be safe than sorry and beef up cash resumes during times of high employment.”
However, selling investments to get cash in anticipation of a recession is risky. You might sell prematurely and get trapped in cash as markets rise. A better strategy is to shift into investments that are well-positioned to weather a recession.
This is why keeping a certain part of your portfolio in cash or highly liquid securities, like a money market mutual fund, is always wise.
Own Defensive Stocks in a Recession
Consumer discretionary stocks tend to see strong gains when the economy is growing. They’re called cyclical stocks, since gains and losses in this group depend on the rise and fall of economic cycles and consumer confidence.
Defensive names in non-cyclical sectors like utility stocks and consumer staples stocks tend to be insulated from those ups and downs. During a recession, defensive stocks can help protect your portfolio.
“Companies that sell essential services and goods, such as food, electricity (and) shelter are generally non-cyclical and less exposed to economic cycles,” Katz says.
Sales of consumer staples—food, beverages and household products—are fairly recession-proof because no matter how poorly the economy is doing, people still need to eat and use toilet paper. Demand for utilities also holds up in a recession, helping utilities outperform other stock sectors during a downturn.
“The health care sector is stable across the business cycle,” wrote NBER analysts in a 2021 report. “If anything, when counties experience more severe economic downturns, healthcare employment seems to increase.”
Use Dollar-Cost Averaging
Dollar-cost averaging is an investing strategy where you buy a fixed amount of an investment on a regular basis, regardless of the current price.
Recessions are great opportunities to use a dollar-cost averaging approach because you’ll buy shares as the price declines. You can dollar cost average with new money or simply set your dividends to automatically reinvest in the security, which would serve the same purpose.
Buy Quality Assets During a Recession
“Investors should seek out quality across asset classes to protect a portfolio during a downturn,” Katz says. “Low beta, high return on investments and low leverage are hallmarks of quality investments.”
He calls such companies “all-weather businesses” that do not depend on economic growth to thrive or survive. Companies with high recurring revenue, such as subscription-based sales models, are less sensitive to economic downturns.
He says you want to avoid companies with high debt loads as they could have trouble servicing their debt if revenues and cash flows decline. They could also have trouble refinancing debt at maturity if credit conditions and lending standards tighten.
Avoid Growth Stocks During a Recession
Heading toward a potential recession is not the time to own growth stocks.
“Growth stocks, especially profitless companies that are tied to high growth prospects, do worse during recessions,” Nakadi says.
Instead, consider more income-producing investments and dividend-paying stocks.
Invest in Dividend Stocks
The best dividend stocks provide a cushion for your portfolio during recessions. Even if a company’s stock price falls, it may keep paying dividends.
“Dividends can indicate strength and offer a method to dollar cost average during market volatility,” Griffith says.
Consider Actively Managed Funds
For fund investors, consider shifting into more actively managed funds during a recession.
Research shows that most actively managed funds outperformed their peers by 4.5% to 6.1% per year in down markets after adjusting for risk and expenses.
Bonds and Uncorrelated Assets
Bonds also tend to do well during recessions, but Katz says to guard against rising defaults by sticking to investment-grade bonds.
“Lastly, truly uncorrelated asset classes, such as royalties, insurance-linked securities and carbon credits, may do relatively well when traditional asset classes exhibit weakness,” he says.
Don’t Overreact During a Recession
Even if a recession is on the horizon, no one can know how long it will last or to what degree it will affect the stock market. Often, the best way to invest during a recession is just what you’ve already been doing.
“While (recessions) can be challenging for returns and growing wealth, we also see countercyclical rallies and the market is always forward-looking, so the keys are to remain fully invested, not be whipsawed by short-term market gyrations and to keep (focused) on your long-term goals,” Nakadi says.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
