Considerations before investing in a recession

2 October 2020
On September 2, the Federal Government confirmed the Australian economy was in a recession for the first time in almost 30 years. Yet, on the same day we learned that our economy had experienced one of the biggest economic plunges in our history, the Australian stock market was up almost 2%. A daily rise of that size is a fantastic day on the markets!

Why the disconnect between negative economic news and a positive share market reaction on the exact same day?

First of all, the data used to determine recessions is ‘backwards looking’. It tells you what has happened for a period of time in the past. In this instance, the data told us that Australia’s economy had contracted in consecutive quarters.

This differs to professional investors and analysts who are usually ‘forward looking’. These investors are trying to work out what will happen in the future. Many look to predicted PE ratios (known as price to earnings ratios) for the next 12 months rather than what happened in previous months or quarters.

Considering the average recession is around 11 months (according to NBER data), it means that even during a recession the stock market may already be pricing in the upside to come.

But it’s anyone’s guess whether these investors will be accurate with their predictions.

If the average recession is around 11 months it means that for every recession that is around 6 months long, there would need to be one around 16 months long to maintain the average. As famous investor Howard Marks once said, “Never forget the six-foot-tall man who drowned crossing the stream that was five feet deep on average.”

With this in mind, be careful about trying to predict the future. But at the same time, don’t let the bad news of today guide your long-term investment philosophy.

Timing the market

Buy low, sell high sounds easy in theory, but the reality is that most professionals can’t do this consistently. The annual SPIVA report, produced by world ratings agency Standard and Poors, shows that most active fund managers actually underperform their benchmark.

It can be more prudent to focus on ‘time’ in the market rather than ‘timing’. From February 19 this year, the S&P 500 index dropped 34% over a four-week period. During this time, many people sold their shares in fear of potential further falls. But over the next five months, the market then experienced a meteoric rise of 60%. This period was one of the greatest periods on record of stock market returns over such a short period of time. Those that missed this run potentially missed out in a once-in-a-decade period of returns. There’s a famous study by JP Morgan that showed six of the 10 best days on the stock market fell within two weeks of the 10 worst days. It’s very hard, if not impossible to predict these day-to-day movements!

Diversify to protect against an unknown future

Australians are fanatical about football. It makes sense to pick one team and support them passionately. But investing isn’t football. It’s okay when you invest to have interests in lots of teams – from growth assets such as Australian and international equities (stocks), defensive asset classes such as bonds and cash, and assets in between such as property and infrastructure. Some will win, some will lose, but your portfolio will be resilient to withstand all sorts of situations, including investing in a recession.

Keep your fees low

Einstein is credited as speaking of the power of compound returns; “He who understands it, earns it; he who doesn’t, pays it.” As great as compound returns are, the amount of fees you pay (be it trading costs or management fees) can erode the power away. Exchange-traded funds (ETFs) provide investors with ways to get exposure to multiple asset classes in a low cost way. Keeping your fees low is one of the few things you can control.

Get professional help

While some people may be comfortable to create and manage an investment portfolio for themselves, for those who see value in getting a level of professional help there are now low-cost online providers that can help you. The industry refers to them as ‘robo-advisers’, and Australian providers like Six Park can help. They can help set you up with a diversified portfolio over multiple asset classes and importantly charge a low fee too.

Considerations before investing in a recession

It can be really interesting to follow economic news about what has happened or is going on in the world. But remember the stock market isn’t the economy. Don’t assume that today’s economic news will be an accurate predictor for what will always play out on the share market.

If you’re comparing Online Share Trading companies, the comparison table below displays some of the companies available on Canstar’s database with links to the company’s website. The information displayed is based on an average of 6 trades per month. Please note the table is sorted by Star Rating (highest to lowest) followed by provider name (alphabetical). Use Canstar’s Online Share Trading comparison selector to view a wider range of Online Share Trading companies.

Ted Richards Six ParkTed Richards

Ted Richards is Head of Distribution at online investment service Six Park and host of investment podcast The Richards Report. Six Park is one of Australia’s leading providers of online investment management, allowing more Australians to access affordable professional investment management, whether they’re first-time or seasoned investors.

This article was reviewed by our Content Producer Isabella Shoard before it was published as part of our fact-checking process.

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