Investing in the Stock Market During a Deep Recession
Matt Kaldor is a senior content writer with BetterTrades (http://www.FreddieRick.com), the nation’s No. 1 stock market education company founded by Freddie Rick.
As we emerge from one of the deepest recessions since the Great Depression, investors are learning they must have an investment strategy in place if the stock market goes into a tailspin.
Learning how to invest in the context of the economy is a crucial trading tool all investors should count amongst their assets. Creating an investment strategy that accounts for the potentiality of a downturn in equity markets is crucial for successful investing.
The safest haven for an investor’s portfolio at the outset of an ensuing recession is the Treasury market. Flight to safety investing involves buying assets with little-to-no credit risk. Chief among these safe-haven assets are U.S. Treasurys.
When an economy is exposed to recessionary risks, central banks will often move to lower interest rates. Investors often redirect funds from riskier assets like stocks into Treasury securities, effectively driving bond prices higher and yields even lower.
In the equity market, sectors that perform better during downturns in the economy are utilities, healthcare, and consumer staples. Stocks in these groups considered defensive because they are less sensitive to ups and downs associated with the boom/bust business cycle.
In reality, there are almost no recession proof stocks, but counter-cyclical sectors are often able to ride out tougher times better than their counterparts.
Utility stocks are sought out during recessions because these companies provide services considered living necessities. Consumers cut out other discretionary spending before they reduce their utility usage for things like water, electricity, and heat.
Health care stocks are somewhat resistant to recessions because households value medical services and are slow to rein in their spending on it.
Consumer staples are also defensive in nature. People still need soap, shampoo, toothpaste, and other essentials during recessions. In the consumer staples segment, so-called sin stocks – i.e. beer, tobacco – become attractive investments. The rationale for relative outperformance by sin stocks during recessions is that people still have their vices, regardless of the condition of the economy.
Defensive sectors can mitigate dramatic losses often linked to cyclical sectors like financials, energy, and materials. Traders often seek out these cyclically sensitive sectors to apply bearish trades like shorting and put buying. Bears look for stocks that have overshot in price during expansionary phases for short plays. As an example, financials were heavily shorted during the 2007-2009 recession and technology stocks were targeted by bears after the “dotcom” bubble burst.
A viable alternative to investing in the stock market during a deep recession is not investing at all. Many investors choose to sit in cash to ride out an equity bubble or re-pricing. Cash positions reduce equity risk exposure, but it does leave investors open to purchasing power erosion due to inflation.
While investment funds lying dormant are subject to inflation, recessions are often linked with periods of deflation, effectively lessening the impact of purchasing power erosion. Cash positions also provide an investor with the flexibility to build positions in beaten down equity prices as an economy emerges from a recession.
Investment strategies can vary during recessionary periods. Anyone can make money during the good times, but successful, longstanding investors are those prepared to cope with bear markets.
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