Equity Trading in a Time of Recession
After the latest financials showed the US economy shrank for the second quarter in a row, many people are asked whether the country is officially in recession or now.
The circumstances described above have certainly been how recession was traditionally defined, but there is some question as to whether those old definitions are still appropriate given several extenuating factors such as the robust labor market the US is currently enjoying – recessions traditionally being accompanied by mass unemployment and a lack of available jobs.
"The economy is only in a period of transition,” declared Treasury Secretary, Janet Yellen during a White House press briefing in July 2022. "I would be amazed if they would declare this period to be a recession, even if it happens to have two quarters of negative growth,” she said, adding that the economy had rapidly grown 5.5% last year. "We have a very strong labor market. When you are creating almost 400,000 jobs a month, that is not a recession.”
However, with the economy shrinking Wall Street is certainly adopting a recession perspective, leading many traders to search for new methods of doing business in this climate.
Stock Markets During Recession
As the economy continues to contract, we can expect to see a fall in stock market prices as the revenues of firms decline. Even without the US technically being in recession, the cost-of-living crisis being felt by households throughout the nation mean citizens have less money to spend than they previously did.
This means not all companies listed on the stock exchange will see the same level of impact. Essential sectors such as energy, healthcare, and staples such as supermarkets and other customer goods stores are likely to continue to perform well, while those brands dealing in "luxury” goods and services such as travel, durables, leisure, and so-on are the ones which are most likely to feel the pinch.
Stock pricing volatility also becomes an issue during these periods as those companies without effective risk management strategies attached to them are forced into selling.
However, while the stock market might be somewhat connected to the official economic health of country, that doesn’t mean it is entirely bound to it. For example, during the Great Recession banks pumped significant amounts of cash into the economy. This increased availability of liquidity led to investors buying heavily into stocks during the period and playing a waiting game for the economy to recover and the value those companies invested in to be restored.
How to Make the Most of the Situation
So, we know how to identify when a market is in recession, and we now have a greater understanding of how the stock market behaves under such circumstances. The next step therefore is to identify the opportunities which exist under recession-like conditions and make the most of them until the economy is in a healthier state.
Going short is one method investors can deploy. This does take a bit of research, but short-term investors can make the most of the sharp decline by investing in those sectors which are likely to underperform under recession conditions – sectors such as technology and real-estate – and selling forwards.
While this is going on, you can be developing a plan for the post-recession landscape. Identify which sectors and markets are going to see the most rapid recovery once the situation has passed and develop strategies for making the most of an economy looking to bounce back.
Hedging, by leveraging positions in two different equity sectors, can also help investors in both long and short positions to navigate the market during these times.
Finally, investment in so-called safe havens such as gold has historically been an effective method of protecting value during times of recession. Out of the previous seven recessions experienced by the US economy, gold has yielded positive returns five times, with a median performance of 6.4% throughout the downturn periods.
"A recession raises unemployment and reduces inflation, providing the Federal Reserve leeway to slash interest rates and reactivate the money printer to stimulate the economy,” writes Capital,com. "A fall in interest rates and the expansion of the Federal Reserve's balance sheet through quantitative easing measures are the primary channels by which a real and supply-constrained asset like gold tends to increase in value during recessions.”
However, it should be noted that this recession would seem to be unique in that unemployment will likely not be a factor. Investors should investigate thoroughly whether this fact will have a significant impact on the outlook for gold value during the period.
Final Thoughts
As recession looms, investors need to begin planning how they will best navigate these turbulent times – especially taking into account the uniqueness of the current environment. Identifying opportunities and making the most of each one will give you the best chance of continuing success through the hardships and beyond.
The looming recession is certain to be part of the conversation at Equities Leaders Summit 2023, taking place in January at the Eden Roc Miami Beach, FL.
Download the agenda today for more information and insights.