*UPDATE* In early August 2022, the Bank of England warned that the UK will likely fall into recession at the end of 2022 after raising interest rates to 1.75% - the highest it's been since late 2008. The below article talks about what a recession is and what the impacts could be, with a focus on investing during a recession.
If one word could be used to sum up financial markets in 2022, it’s ‘inflation’, and in recent weeks, we’ve seen central banks taking aggressive steps to try and reduce the impact it’s having on the cost of living.
Leading the charge is the United States’ Federal Reserve, which last month raised interest rates by ¾ of a percentage point – the biggest single increase since 1994.
What impact did this have?
The stock market has already had a difficult year, especially with the uncertainty surrounding the invasion of Ukraine back in February. The announcement by the Federal Reserve saw the US’s largest index (the S&P500) fall 20% lower than its recent peak – triggering a bear market (bear markets happen when a stock index falls 20% from its recent high).
Historically, bear markets often lead to recessions, but is this true today? Let’s take a quick look at whether a recession is likely in the near future, and if so, how serious it would be and what it might mean for your investment plan.
What is a recession?
Just so we’re all on the same page, a recession is what happens if the economy contracts (the opposite of grows) over two back-to-back quarters – or six months.
If the figures show that the economy has been in decline for six months, then that’s the decision made. Think of it more as a mathematical equation than a political or economic choice.
The Bank of England hasn’t predicted that the UK will enter a recession any time soon. However, they have said that they’re expecting quite a significant downturn towards the end of the year.
Are we going to enter a recession?
Many of us are feeling the pinch from the increased cost of living, and there’s further pressure expected to come from rising oil and gas prices, as well as a second spike in energy prices expected later this year. So “are we entering a recession?” is the question on everyone’s lips right now.
Sadly, the answer isn’t a simple yes or no. It’s actually a bit more complicated than we’d like it to be.
There are a lot of different factors at play, and while on their own they aren’t showstoppers, together they really pile up. Some of these factors are:
- Covid lockdowns – while in the UK almost all restrictions are lifted so for us, lockdowns feel like a thing of the past they’re still common in other parts of the world, such as China. This is causing issues with supply chains and slowing down economic growth.
- Russia’s invasion of Ukraine – the shocking nature of this attack has caused issues not just with the stock markets, but also with the international gas and oil market. In addition to that, we’ve seen issues in food production and agriculture come out of this.
- Household bills – inflation is running rampant, and this rising cost of living is leaving many households with less money to spend. And less spending ultimately leads to lower economic growth.
- Supply chain shortages - many rising prices stem from a lack of supply to match the demand. Hiking interest rates won’t increase the production of gas and oil to make it any cheaper for customers, it’ll just reduce their buying power.
Touching on that last point, one of the biggest things we saw to keep the economy afloat has been consumer demand. People have been wanting to buy things due to Covid lockdowns, and many of them managed to save a lot of cash during the pandemic - according to the Office of National Statistics, the average household managed to save around 10% of their annual disposable income. These savings helped to boost the economy with increased consumer demand, causing companies and manufacturers to try and increase their supply to keep up.
However, as inflation increases and the pressure is added on, this desire to spend is falling once again. Combined with Central Banks raising interest rates, the cost of debt is also increasing. In theory, this should slow down spending further as there may be a point when people’s confidence in paying back debt is too low for them to justify further purchases.
What happens if the economy slows down too quickly?
If the economy slows down too quickly, it could contract and spark a recession.
Right now, there’s a balancing act between reducing inflation and keeping the economy afloat. However, accounting to a survey by the Financial Times, nearly 70% of US macroeconomic experts think that the US is likely to go into recession in 2023.
While that suggests it’s highly likely, it is still not a certainty.
It’s also worth saying here that we don’t expect a deep recession as we had following the 2008 Global Financial Crash. And while any recession is likely to bring issues, a shallow recession would not become a major problem. This is especially true as the driving force behind this has been an intentional slowdown in an environment of high demand and supply shocks. Central banks are actively trying to drive down demand to restore balance and lower the level of inflation. If these measures start to have a very negative impact on the economy, then they still have the option to reverse these policy measures.
What does all of this mean for my investments?
It’s difficult to say, but at the moment, the stock market is currently trending downwards. Which, depending on your outlook, could be a great opportunity.
One way that you could make money from investing is to buy when the price is low and sell when the price is high. Well, right now, the price of many investments is very low compared with historical averages – with some companies and even entire global regions being highly undervalued.
We’ve seen many successful companies see their share prices dropping significantly throughout the first half of 2022, this includes the likes of Apple, Amazon, Microsoft, ASOS, Tesco and Tesla.
In fact, the only obvious exceptions are the oil and gas industries. It's likely that we’re going to continue to see continued market turbulence throughout 2022 and into 2023, which is why considering a long-term approach to investing could give you more potential to ride out market dips.
Time in the market, not timing the market
We’ve talked before about how difficult it is to time the markets. To do it properly, you’d need a crystal ball and plenty of skill on how to read it.
In reality, timing the market is nearly impossible to do consistently, but that doesn’t really matter that much. At Wealthify, we believe in ‘time in the markets’ rather than timing the market. While timing the market is obviously desirable, it’s incredibly hard to do and impossible to do consistently. Taking a long-term approach instead focuses on the potential for growth over time, rather than the off chance that you’re able to buy or sell at exactly the right moment.
One way to consider taking advantage of market drops (which could also help mellow out your investment journey) is to use an investment strategy called “pound cost averaging.” This is a technique that simply drip feeds your investment account little and often, buying investments at loads of different prices.
Say you started investing in January 2022, but with a Direct Debit to buy investments every month. In January, you might have bought a few investments at higher prices, but then as the markets have dropped, you’ll have picked up those same investments at discounted rates – meaning you own more of them for less money. The lower the price goes, the more investments you pick up.
However, if the price of those investments goes back up, you won’t get quite as much for your money. But on the other hand, all the investments you bought at lower prices will also go up in value, potentially giving your investment plan a nice little boost.
Over the long-term, taking this approach could help to balance out the overall price you pay for your investments – taking the edge off the highs and lows, and giving you a much smoother investment journey. Using this investment strategy during a recession could help you to drive the pound cost average of the price you pay lower, giving you more potential for profit in the long term.
- Data from Bloomberg
Please remember that past performance is not a reliable indicator of your future results.
With investing your capital is at risk, so the value of your investments can go down as well as up, which means you could get back less than you initially invested.
Wealthify does not offer advice, if you’re not sure whether investing is right for you, then please speak to a financial adviser.