Investing in a Recession

Definition: A recession is characterized by two consecutive quarters of declining GDP growth. Because of the turbulence during recessions, it is crucial to understand how to manage your investments.

Key Ideas

  • The Federal Reserve acts as a manager to mitigate the effects of a recession on the US economy
  • Interest rates heavily dictate the trajectory of the US economy due to their ability to encourage investment into the different industries and the willingness to take on debt
  • During recessions, investors can invest in safer assets that yield more consistent streams of income while the stock market rebounds

Setting the Scene

A recession is usually associated with higher unemployment, a significant decline in economic activity across the market, tighter budgets, and overall financial hardships. In a technical sense, a recession is seen by many as two consecutive quarters of decline in a country’s real GDP. Using this indicator, the US has seen 3 recessions this century: 2001, 2008, and 2020. While all 3 recessions appear to fit the definition of one, one fundamental difference is the personalities of each recession. 

Known as the dot-com bubble, 2001 was characterized by massive market declines in an inflated tech environment that caused unemployment to rise to as high as 6.2% by 2003. This was in addition to the destruction and closure of many tech companies known as “dot-com” companies due to their usage of the internet and “.com” as the suffix of their business name. 2008, or the Great Recession, is the most salient recession in the minds of US citizens for the massive havoc it wreaked on the real estate market, breaking the established standards of lending and securitized mortgages. During this one, unemployment rates skyrocketed to then-historic highs of 10%.

Fast-forward to 2020 to the most uncharacteristic recession we have seen yet. With market declines of over 30% between the months of February and March 2020, many individuals were shocked and buckling up for another couple of years of pain and loss. However, by August, the market was back to its previous high! Was everything really back to normal?

Who Is At The Wheel?

During a recession, the federal reserve (“the Fed”) is responsible for using monetary policy to guide our country into better economic conditions. By toggling interest rates and injecting money into our economy, the federal reserve takes control of our economy in an attempt to drive the American public out of a recession.

Lower interest rates can have a positive impact on the economy during a recession. They can encourage consumers to spend more and businesses to invest more, which can lead to job creation and economic growth. Lower interest rates can also make it easier for people to buy homes or take out loans for education or other investments. However, it's important to note that lower interest rates can also have negative consequences, such as inflation. If interest rates are too low for too long, it can lead to inflation as the demand for goods and services increases.

How do I take advantage of this?

As an investor, lower interest rates can present an opportunity for investors to invest in the market. As discussed, lower interest rates stimulate the economy and increase stock prices. To take advantage of declining interest rates, investors could allocate more of their portfolio toward stocks during a recession.

Conversely, when interest rates are high, investing in bonds may become more attractive. Higher interest rates mean higher bond yields. Investors could consider increasing their allocation towards bonds to develop a fixed income stream at a relatively low risk. Remember how inflation is a consequence of low interest rates? Eventually, the Fed will decide to increase interest rates in an event known as a “Fed Pivot”.

A "Fed pivot," or a change in monetary policy by the Federal Reserve, can also impact the attractiveness of bonds. When the Fed signals that it will be raising interest rates, bonds with higher yields become more attractive, and investors may consider shifting toward bonds.