Dark clouds have appeared on the horizon for investors around the world.
The supply chain havoc caused by business disruption during the pandemic has been turbocharged by a rebound in activity after lockdowns have ceased.
War in Ukraine has switched off large portions of European agricultural supplies of staples such as wheat. Furthermore, concerted efforts by EU nations to end imports of Russian oil have led to fossil fuel commodity prices hitting all-time highs.
Both of these events have created the perfect storm of inflationary headwinds, causing consumer spending power to fall and reducing disposable incomes for luxury goods.
Despite the existence of other indicators of economic expansion; (low unemployment and a booming residential property market), these are soon expected to pave way for a recession.
Each of these economic indicators can be attributed to a consequence of the pandemic. The low unemployment rate reflects the fact that many older workers decided to leave the workforce entirely during the pandemic, a combination of their own choice or bad health.
The booming property market is attributed to an accumulation of ‘lockdown savings’ which meant a surge of new buyers were armed with a deposit to go hunting for a property as soon as the pandemic abated.
However there are signs that times are changing, mortgage approvals have fallen to the lowest level in two years and spiralling wage bills have choked corporate margins, resulting in a wave of profit warnings.
The debate about growth in the UK
Economists are now separated into two camps; those that believe a recession is inevitable, (and indeed necessary for the economy to stop overheating). The other camp expects the Bank of England to stall the economy but manages to narrowly avoid a technical recession.
In either case, a few successive quarters with depressed growth may be enough to alter the mindset of businesses and investors. Growth has been low in real terms since 2012, but, pandemics aside, it has remained around 0.3% – 0.6% per quarter.
Stalled growth will mark a backstop against the “rebound” strategies of many of the best public companies, that have been in place since pandemic restrictions eased. This phase saw recruitment taps switched turned wide open and Capex plans restarted.
While UK politicians from virtually all parties are labelling sluggish UK economic growth as a key priority, it’s unlikely that any immediate actions will have much effect. The UK is trailing behind the rest of the G7 group of rich nations, with key drivers including underinvestment in capital expenditure, education & training.
How Investors Can Prepare
To prepare for a possible recession in the UK, investors could take several steps:
- Assume the momentum of interest rate rises will continue
Central bankers in London, Washington and Brussels are determined to cut inflation, regardless of the collateral damage, as inflation has become enemy number one to living standards across most economies.
This means that investors should be prepared for rates to rise, (albeit temporarily) above equilibrium, which may be as high as 3% in the UK – a rate not seen in over a decade.
Have stock markets really priced in the effect of this curve? It remains to be seen. Further equity market falls could be on the cards as inflation proves to be persistent.
This means investors would be wise not to lock into 3 or 5-year savings bonds as the current crop of offers will likely be beaten with months by a tasty margin.
- Consider your largest sector exposures
In a recessionary environment, you could consider which sectors you’re exposed to via your equity portfolio. Your stock account should provide a quick analysis of your sector exposure, but if that fails, just look at the Fund Factsheet of your fund or ETF to understand how the main indices split their holdings by sector.
Essential goods such as water, energy, infrastructure and military are considered ‘defensive’ sectors. The companies in this sector will have a solid revenue pipeline that won’t be as affected by economic events as they are either non-discretionary purposes or they’re financed by the government.
On the other hand, luxury goods, experiences & retail is often the hardest hit by shrinking consumer confidence.
There is no way to totally protect an investment portfolio from recession, particularly amid rate rises, because few assets will actually rise in a falling tide.