What should be your investment strategy in a recession

What should be your investment strategy in a recession?

In stock markets, there is a famous saying, “Bulls and bears make money; eventually, the pigs get slaughtered.” In a sense, that is true. There are opportunities to buy and sell stocks irrespective of the levels of Nifty and Sensex. The big question is does it make sense to invest in a recession? Let us first look at two classic examples of Indian stocks.

In 1996, India saw monetary tightness and macro risks of a high order. The Asian crisis of 1997 only worsened the situation. However, Equity investors who bought Infosys at that point multiplied their money many times over by 1999. They would still be sitting on a pile if they held on till today. Secondly, in the aftermath of the global financial crisis, Eicher was available in double digits in 2009. Had you bought that stock amidst recession fears in 2009, you would be sitting on a hundred-bagger!

But what exactly is a recession?

The macroeconomic definition of a recession is two consecutive quarters of negative GDP growth. Of course, there is a more whacky definition, “When your neighbour loses his job it is a slowdown, but when you lose your job, it is a recession”. On a more serious note, why are we discussing recession in the current context?

Recession signals are already there in the US. In the March 2022 quarter, the US GDP showed a -1.6% contraction. It is estimated that the June quarter could either see flat or negative GDP growth. In addition, the yield curve has been inverting (2-year yields are higher than 5-year yields). In the US, an inverted yield curve predicted 80-85% of recessions. There is also the Fed, which is overly hawkish, and the apprehension is that aggressive rate hikes can impact economic growth. 

Should you buy stocks in a recession; if so, how?

We often use the word recession too loosely. It is not just a temporary fall in growth but a long-term impact on output and incomes. The more optimistic approach is that a recession means a correction in stock markets so that bargains would be available. That may not necessarily be the case. One thing investors must be careful about is catching a falling knife. If a cyclical or low-quality stock falls vertically, there is no point trying to bargain hunt. 

That brings us to the million-dollar question. How do you buy stocks in a recession or a falling market in response to fears of economic slowdown? There are 5 approaches.

The first way to bargain hunt is to stick to the leaders in the industry. In tough times, leaders with deeper pockets and a pedigree in the business manage to make the cut. A cyclical commodity play may not be the best choice in a recession because, usually, long-term commodity cycles end in a recession. That is when most of the price damage happens. We have seen that when commodities topped out after the global financial crisis.

Low debt is the mantra. In a recession, companies with zero or low debt typically do well. That is one reason why the IT sector in India has managed to bounce sharply post every economic crisis. Low debt levels put them in the best position to trigger a turnaround in their fortunes.   Focus on the stocks that fall the least during a sell-off. For example, you may find that pharma stocks, IT, FMCG and select banks may not fall too hard in a sell-off. These are the ones that are less vulnerable to a slowdown in the economy. As popular wisdom goes, even if the economy slows down, people still need medicines and detergents.   A recession is a time to restructure your portfolio. Go short on the losers and go long on the winners. Here we are talking about churning your portfolio. There is an element of portfolio lethargy that most investors are subjected to. That compels them to postpone a portfolio restructuring decision. The recession and the fall in stock markets is an opportunity to churn the portfolio and bring it back to the original asset allocation and to explore new asset classes. Decision points are much clearer.  Finally, let us not forget the power of mutual funds, especially systematic investment plans (SIPs). They not only accumulate wealth systematically but also make the best of market falls. If direct equity or if you are investing for first time in equity and it is not you cup of tea  then a phased approach to equity mutual funds will work wonders for you.

To sum up, not all is lost for investors in a recession. More than opportunities; when markets correct on recession fears, they give your portfolio a lot of clarity. Make the best of it.