The UK economy took a downturn in the last half of 2023, shrinking – by 0.1% in Q3 and by 0.3% in Q4. Since economic recession is generally defined as two or more consecutive quarters of decline in GDP, technically it’s an economy in recession. The Office for National Statistics recently released new data providing a number of insights into the evolution of the economy in the first months of 2024.

The good news is that Consumer Price Index (CPI) inflation is on a downward trend, which will probably bring overall inflation down to the Bank of England’s 2% target during the spring – a positive prospect for renewed growth – but it may well rise again over the year.

In a period of fluctuating recession like this, an investor needs to react to the state of the market but cannot simply cease all activity. To better understand how the economy works and how to handle a recession, we need to start with the business cycle.

Four Phases of the Business Cycle

The business cycle is generally composed of four different phases of activity, each of which can last for months or years. During the expansion phase, the economy is healthy and growing with share prices that can rise to all-time highs at the peak of expansion. On the flip side, prices tend to rise due to inflation but despite this, most businesses, workers and investors are enjoying the good times.

After the peak comes the contraction or recession phase, when production and employment begin to decline due to any number of reasons. Companies struggle to stay profitable; unemployment rises and consumer spending decreases in a vicious cycle of economic contraction. Markets are volatile with share prices experiencing wild swings, causing some investors to pull their money out of the stock market entirely.

The trough is the point where business activity moves from contraction to recovery. Production and employment bottom out, and stock prices start to increase after a significant decline. Troughs can be difficult to identify while they are happening, but they are recognizable in hindsight.

During the recovery phase the economy begins to grow again. Production increases, as does employment, while wages go up and consumers spend more. This allows companies to charge more for products and services, catalysing inflation that can bring growth to a halt and start the cycle again if it becomes too high. However, over the long-term most economies tend to grow, and each peak is higher than the previous one.

Being Prepared for Recession Phase

Previously, I’ve discussed portfolio diversification as an important element of your investing strategy that can be used to mitigate risks, because a well-executed asset allocation strategy allows you to avoid the potential pitfalls of placing all your eggs in one basket. Having a portfolio spread across different asset classes, industries and currencies is the essence of diversification.

Every investor’s situation is different, and your own investment choices should be made on informed decisions after extensive research into markets and assessments of risk factors. If you have clearly quantified your risk tolerance and diversified your portfolio, you should be in a good position to ride out the downturn.

If you haven’t, do it now – there’s always another recession in the future so be prepared.

Keep Calm and Don’t Panic

When recession hits, what should an investor do? Firstly, always remember that the market is cyclical. What goes up must come down, but the opposite is equally true, and downturns are only temporary. The market plummeted during the 2008 financial crisis, but it bottomed in March 2009 and eventually rose back to its former levels and well beyond.

It has also recovered from the initially brutal economic impact of the Covid 19 pandemic. Successful investors understand the cyclical nature of the market and the economy and position themselves to ride out the lows and take advantage of the highs.

So, when the value of your portfolio decreases significantly and your gut reaction is to start pulling money out of the market, you need to use your head instead and think long-term. Above all, don’t panic, because panic-selling will lock in greater recession-related losses in the long run.

This further reinforces the importance of establishing your risk tolerance in advance, when you are in the process of setting up your portfolio, and not when the market takes a downturn, and an emotional response tempts you to panic sell “before things get any worse”. It takes patience, not panic, to be a successful investor.

Is it Safe to Invest During a Recession?

During a recession, lower stock values can actually represent good opportunities for new and relatively cheap investments, but only if you have a strong enough financial position and the right attitude. During a recession, you can buy at a low and see the value go even lower just a few days later, so don’t check your portfolio obsessively every day because this can tempt you into hasty decisions and the panic-selling that I discussed earlier.

Investing in times of recession requires a truly long-term approach, so plan on leaving any new investments alone for at least seven years.

Best Investments During a Recession

While there’s no such thing as a ‘recession-proof’ investment, certain core sectors can provide insulation in an economic downturn. Consider utilities and consumer staples – people will always spend money on health care, non-durable household goods and food and beverage, regardless of the state of the economy. These stocks may not perform outstandingly in boom phases, but they are relatively stable when the rest of the economy is on shaky ground and can continue to provide steady returns during a recession.

We are investors, not economists, so understanding the business cycle is only useful if it translates into improved portfolio management and higher returns. Instead of joining the flight to safety and bailing out when recession hits, try to consider it as a time to prepare for the rebound that will inevitably arrive afterwards.