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Morningstar Insights: How Should I Survive The Recession?

Fernando Luque, Senior Financial Editor at Morningstar Spain thinks that asking if there will be a recession (and how to avoid it) misses the point. The best questions people are asking are ‘am I okay?’ and potentially ‘can I do something smart?’

One of the issues that likely will worry investors in 2023 is the possibility of suffering through a recession. A recession will have an impact on both the daily life, and the working life, of citizens. But it will also impact our investments, as recessions affect corporate earnings, interest rates and the valuation of different asset classes

Supply Chains: A New Year’s Resolution?

Mike Coop, chief investment officer, Europe, Middle-East & Africa for Morningstar Investment Management agrees that “as investors, the reality is that a recession appears the most likely scenario for many countries”.

However, it is impossible to know both the severity and duration of any potential recession. According to Preston Caldwell, Morningstar’s head of US economic research, it’s a virtual coin toss – at least in the US, which accounts for around a quarter of the global GDP and over 60% of the global stock market.

He stresses the need to look beyond 2023: “either way, we expect growth to accelerate again in 2024 as the Federal Reserve lifts off the brakes”, he says.

It’s not all bad news for 2023. The resolution of supply chain issues has begun to lower the price of goods and should continue to stamp down inflation. Caldwell forecasts inflation has a reasonable probability of receding to normal levels in 2023 and could even undershoot the Fed’s 2% inflation target by 2024.

What Should I Do Now?

Coop also stresses the fact every investor will endure multiple recessions in their lifetimes. The key is how we deal with them, as recessions have a habit of bringing out the worst in investors. He offers three recommendations for investors to deal with a recession (which are the foundations of Morningstar Investment Management):

Goal Setting as a True North 

Coop says it is important to make sure your goals and objectives remain relevant. “Given the changes we’ve experienced in recent years, it is not unusual for these goals to have shifted. This includes confirming the timeframe for reaching them. Whatever the outcome of this review, there are big advantages of measuring success in terms of progress to reaching your goals, rather than beating the market”.

Stay the Course with a Well-Diversified Portfolio 

Coop recommends erring on the side of caution every time there is a period of uncertainty, adding “check you are taking the right amount of risk to reach your goals – one that you can live with in bad times and one that will be enough to at least keep pace with inflation.” How to do this? Simply by having a diversified portfolio including assets that behave differently to others when there is recession – such as equities and high-quality bonds.

Use Valuation to Get the Odds in your Favor

Coops also thinks it’s “desirable to favour assets that already reflect pessimism about the future as they are less prone to falling than assets that are highly popular, have gone up a lot and are priced for the best possible scenario – and therefore, not very likely to occur.

“Within equities, we find it imperative to balance exposure between the most attractively valued assets along with stabilisers such as dominant companies with little debt and goods and services that are perennially in demand. Examples can often be found in areas like healthcare, utilities and consumer staples”.

The Real Issue is Fear

According to Coop, asking if there will be a recession – and how to avoid it – misses the point. The true questions people are asking are “am I okay?” and potentially “can I do something smart at this time?”

While these questions are always well intended, they could lead to dangerous behaviours, and so it is always healthy to center back on the truths of investing during a recession. According to Coop, these are the truths of investing in a recession:

  • To get investment returns you need you to take risk—cash is unlikely to help you beat inflation and grow wealth over time;
  • Recessions are common (occurring every seven-to-10 years on average), temporary (lasting several years) and eventually followed by economic recovery;
  • Stocks tend to front-run the economy, not the other way around. They will also front-run the economy before the recovery happens. This makes market speculation incredibly difficult as you need to get two decisions right (exit point and re-entry point) amid heightened uncertainty. Very few, if any, have this skill;
  • Stocks do have a track record of falling before and during recessions because company profits fall and bankruptcies rise. However, they have always recovered lost ground in the years that follow;
  • Bonds have a good track record because inflation and interest rates tend to fall. Today, rates and yields are high enough for bonds to provide this offset;
  • The main way you fall short of your financial goals is a permanent loss of capital where you never recoup the losses. These can occur in recessions (such as a low-quality investment that goes bankrupt), so care needs to be taken;
  • Three killers that trigger permanent losses are: 1) speculative investments with no basis for their valuation, 2) assets with too much debt, and 3) selling out at the bottom because of behavioural biases;
  • Buying shares when they are cheap tends to lead to higher-than-usual returns because markets price in bad scenarios and there is upside if conditions improve.

Morningstar Disclaimers:

The opinions, information, data, and analyses presented herein do not constitute investment advice; are provided as of the date written; and are subject to change without notice. Every effort has been made to ensure the accuracy of the information provided, but Morningstar makes no warranty, express or implied regarding such information. The information presented herein will be deemed to be superseded by any subsequent versions of this document. Except as otherwise required by law, Morningstar, Inc or its subsidiaries shall not be responsible for any trading decisions, damages or losses resulting from, or related to, the information, data, analyses or opinions or their use. Past performance is not a guide to future returns. The value of investments may go down as well as up and an investor may not get back the amount invested. Reference to any specific security is not a recommendation to buy or sell that security. It is important to note that investments in securities involve risk, including as a result of market and general economic conditions, and will not always be profitable. Indexes are unmanaged and not available for direct investment.

This commentary may contain certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.

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