Many people believe that stock trading during recession periods is more difficult than usual.
The truth, however, is that there is no reason to automatically associate recessions with poor trading environments. History shows us that the markets are often very resilient during recessionary years, frequently finishing in positive territory.
Ultimately, a recession is simply a natural part of the economic cycle – one that plays a key role in keeping economies and markets healthy.
By brushing up on historical trends, you can identify the best trading tactics to deploy during recessions and keep maximizing your opportunities in any market.
What is a Recession?
A recession is typically defined as weak or negative economic growth that extends over a sustained period. Trade and industrial output declines occur during recessionary periods.
Historically, recessions have been declared after Gross Domestic Product (GDP) declines for two successive quarters. GDP is a measure of the market value of all goods and services produced in a specific time within a national economy.
Recessions can be caused by high interest rates, an economic shock (from a pandemic, terrorist attack or other unforseen event), deflation, the popping of asset bubbles or deflation.
Things to Expect During a Recession
Other signals that indicate a recession is at hand include the following:
● Rising unemployment rates. Companies tend to reduce their headcount during recessionary periods to lower costs.
● Lower consumer spending. One reason companies lower costs during recessions is due to a reduction in consumer spending. This reduction is often linked to changing attitudes among consumers about the health of the economy. As consumers lose confidence, they spend less.
● Rising bankruptcies, defaults and foreclosures. As consumers and businesses become more financially stretched, they sometimes lose the ability to meet their debt obligations.
● Falling asset prices. Real estate, equities and other asset classes sometimes experience dips during periods of economic contraction.
It’s important to remember that not every factor may be present during any given recession.
How Do Recessions Affect the Stock Market?
This is the million dollar question for investors. History shows us that the stock market during recession periods exhibits added volatility and performs a bit worse, on average, than in non-recession periods.
The same lack of confidence that consumers have about the economy during a recession sometimes influences the behavior of investors, who may dial back positions, go short or pursue a “flight to quality” strategy by reallocating their portfolio to blue chip stocks, or stock in industries that have shown recession resistance (such as consumer staples and utilities).
Reductions in jobs and/or slashing salaries during a recession may also create cash flow problems among investors, forcing them to liquidate positions or reduce their rate of investment.
Is it Good to Buy Stocks During a Recession?
The key thing to understand about recessions is that they are a natural part of the business cycle. They help economies “heal” from imbalances.
As such, they should not induce panic. From one perspective, recessions that lead to bear markets can be viewed as buying opportunities, as they perform the critical task of cooling off overheated asset valuations.
As the larger business cycle repeats, savvy traders can adjust their tactics to ensure maximum profitability throughout every stage.
Strategies to Invest During a Recession
It’s important to realize that a recession does not necessarily mean a bear market. In 50% of all recession years since World War Two, the S&P 500 has finished in positive territory. Overall, however, the S&P has seen an 8% drop, on average, over the last four recessions.
While it is generally impossible to perfectly time any market, there are some historic trends that can guide your trading. One of the most important trends to recognize is the tendency for the stock market to front-run recessions. Historically, the S&P bottoms about four months before the end of a recession.
From an industry standpoint, we see outperformance among healthcare and consumer staples stocks during recession periods, while automobiles, airlines, entertainment and travel stocks all tend to lag during recessions.
A tried-and-true trading tactic is to hide in defensive, recession-resistant industry positions during downturns, then quickly move into recession-sensitive industry positions once it appears the bottom is near.
This strategy can manage downside risk while enabling traders to take advantage of the assets that suffer the most significant devaluations related to economic contraction. The stock market after recession periods often sees sharp movement higher for stocks in recession sensitive categories.
How RJO Futures Can Guide You During a Recession
For those seeking recession and stock market guidance, RJO Futures has a seasoned team of investment professionals with the experience to help you find optimal trading strategies in any environment.
We combine the human element with a seamless trading platform and the industry’s most advanced set of trading tools.
With RJO Futures in your corner, you can get the most out of your trades in any market. Get in touch with one of our investment professionals today!