In times of recession, investors would have to be careful and stay vigilant while tracking the market landscape for opportunities to select high-quality assets at a lower rates. Though these may be complex environments, they tend to align with the greatest opportunities. Visit MultiBank Group
A recessionary environment brings out the best in the worst-performing assets. They are the ones that are highly leveraged, cyclical, while also being speculative. Companies which happen to be in such categories may show risky behavior and investors need to be cautious or they may go bankrupt.
Conversely, investors who wish to weather the storm and thrive in a period of recession would prefer to invest in high-quality companies which have strong balance sheets, low debt, and good cash flow. They are typically in industries who have a history of surviving difficult economic times.
Types of stocks basis recession risk
To know what are the key assets that one should not invest in is equally important in a recession as it is to learn about the ones which have the potential to be good investments.
Highly Leveraged Companies
In a period of recession, a majority of investors must avoid highly leveraged companies that are heavily under debt and the same is reflected in their balance sheets. Such companies tend to be overburdened by higher-than-average interest payments which could be the reason for an unsustainable debt-to-equity (DE) ratio.
Though such companies find it hard to make their debt payments, they may even have to deal with decreased revenue thanks to the recession. The chances of bankruptcy or at the very least a major fall in shareholder value, increases for these companies as compared to the ones that have lower debt loads.
Cyclical stocks are generally associated with employment as well as consumer confidence, which is negatively affected in a recession. Cyclical stocks typically perform well when the market is moving upwards as consumers have more discretionary income to splurge on non-essential or luxury goods such as high-end cars, furniture, or clothing.
When the economy takes a hit, consumers generally bring down their spending on such discretionary expenses. They try to cut down their expenses on travel, restaurants as well as leisure services. It is because of this reason that cyclical stocks in such industries are affected which makes them not a lucrative option for investments during a recession.
Speculative stocks are generally highly valued based on the shareholder’s optimism. This optimism could be affected in a recession since these are the worst performers in a recession.
Speculative stocks are yet to prove their mettle and are generally looked at as “under-the-radar” opportunities by investors who wish to enter the next big investment opportunity. These high-risk stocks are generally the first ones to take a hit as investors quickly take their money out of the market to invest in safe-haven investments to curtail their market exposure.
Stocks that perform well during a recession
Though it could be tempting to sail through a recession without any exposure to stocks, it may cost you some major opportunities if you have zero exposure. As history shows us, there are several companies which perform well in times of economic slowdown. Investors should spend some time creating a strategy on the basis of counter-cyclical stocks as well as solid balance sheets in industries that are strong enough to power through recession.
Strong Balance Sheets
A good investment strategy in a period of recession is to find firms which have strong balance sheets or steady business models that remain stable even in case of economic slowdowns. A few instances of such firms are utilities, basic consumer goods conglomerates, and defense stocks. If poor economic conditions are expected, investors may often gain exposure to these groups in their portfolios.
When you assess a company’s financial reports, you would be able to establish if they have low debt, healthy cash flows, and are making profit. Such factors need to be taken into account prior to making an investment.
Though it would appear surprising, certain industries tend to perform well in recessions. Investors on the lookout for an investment strategy in market downturns typically add stocks from such strong all-weather industries to their portfolios.
Counter-cyclical stocks do well in recessions since their demand has the tendency to increase when incomes rise or well or if the economy overall becomes uncertain.
The stock price for counter-cyclical stocks traditionally heads in the opposite direction of the ongoing economic trend. During a recession, the value of such stocks go up while in an expansion, they decrease.
Such outperformers typically include firms that belong to industries such as consumer staples, grocery stores, discount stores, firearm and ammunition makers, alcohol manufacturers, cosmetics, and funeral services.
Investing while the economy is recovering
When the economy recovers from a period of recession, investors need to tweak their strategies. Such an environment is associated with low interest rates and better growth.
Highly leveraged, cyclical, and speculative companies remain steady even in recession and are among the top performers. With economic conditions moving back to normal, these firms lead when it comes to springing back and recovering. Counter-cyclical stocks generally don’t thrive in such an environment. Rather, they face pressure as investors shift to gold assets that could bring more growth.
Tip: Risky, leveraged, speculative investments are the ones which benefit from improving investor sentiment as well as the easy money conditions which are hallmarks of a booming economy.
Is It risky to make an investment when we are approaching a recession?
If an economy is close to recession, there’s a strong possibility that markets may also crash and the profits could fall and growth becomes negative. In recession, stock investors should be more cautious as there is a high probability their investments may depreciate. All things aside it is hard to time the market, particularly so in a period of recession. Selling in a market which is plummeting is not wise and it is best to look at it as an opportunity to purchase stocks for the long-term.