THE TERM “A RECESSION” EXPLAINED IN SIMPLE TERMS
Economic development is usually cyclical. Phases of economic upswing and boom are often followed by a phase of economic weakness – the downturn. This can lead to a recession and in the worst case to a depression, which at some point turns into an upswing again. A new business cycle begins. The downturn is also known as a recession (from Latin: recedere = to go back, to recede). There are different definitions of recessions. A common one is: A recession is when an economy shrinks for two consecutive quarters. The shrinkage is usually preceded by a longer period with lower economic growth. If the recession is limited to a short phase with negative growth rates, it is referred to as a “technical recession”. It is usually caused by temporary economic disruptions. Often times, recessions in an economy extend over long periods of time. If they lead to a protracted economic stagnation, this condition is called depression. Recession and depression are not the same, but there is a smooth transition.
BUSINESS CYCLE INFOGRAPHIC WITH RECESSION
What is a recession in business?
In a recession, the business outlook for companies deteriorates. The order books are less full and the demand for goods is weaker. Sentiment barometers such as the well-known ifo business climate index or purchasing manager indices are falling. Consequently, the poor order situation and demand, production overcapacities and full stocks arise.
The companies react to this with production restrictions, short-time working or redundancies for operational reasons. Investments are being deferred. The number of corporate bankruptcies is increasing. As a result of increased short-time work and unemployment, consumers suffer income losses, and uncertainty grows. Private consumption is falling. This exacerbates the downturn. In a recession there is often a slowdown in inflation, and in extreme cases even deflation. Deflation can plunge an economy into a deep depression. Central banks are trying to combat this situation with a loose monetary policy in order to avoid a deflationary spiral.
What does a recession mean for stocks?
In the stock market, a recession shows itself in falling prices, but not necessarily in a crash. Many investors then switch to safer investments, such as bonds. The bear market is a typical phenomenon in times of recession. However, the price development of stocks does not have to run parallel to the economic cycle. If one anticipates an imminent economic recovery on the stock market, prices can rise even if the current economic data is still bad. A prolonged bear market is possible if a prolonged downturn or even a depression is expected. The greater uncertainty in the recession usually results in higher price volatility. The stock market fluctuates between fear and hope – depending on the news.
What does a recession mean for investors?
For owners of shares or equity funds, a recession is usually associated with price losses. The recession has less of an affectt on other investments. That depends on the design of the financial products, but also on the respective framework conditions. Bonds or precious metals are often sought as a “safe haven” in times of crisis. This can then be seen in higher bond prices or a rising gold price . But this is not a “law of nature” – there are also counterexamples to be found. Experience on the stock market confirms that every bear market is followed by a bull market at some point. In earlier recessions, losses were more than offset later. Falling into fear and panic is rarely good advice. Often times, staying power has proven to be a superior strategy for stocks.
GOOD TO KNOW: If existing equity, fund and ETF savings plans are simply saved further with passive investing , the shares can then be acquired particularly cheaply at low prices. You can benefit from the cost-average effect.
How do I actively invest in a recession?
A recession-induced bear market naturally also contains signs of speculation – through countercyclical behavior. Getting in when the prices are particularly low and later selling at a profit – this requires ongoing market observation, in-depth market knowledge and a portion of luck in finding the right time.
Shifts in the equity portfolio can also be worth considering. In the recession, stocks are often sought that do above average on the stock market or are even particularly successful:
Defensive values: This is the name given to shares in companies whose business is not very cyclical. These include, for example, energy suppliers, telecommunications providers or many consumer goods (food industry, manufacturers of basic everyday products);
“Crisis profiteers”: This means values that perform particularly well in the recession. Reason: the crisis is helping the companies concerned to do more business. This could be pharmaceutical and biotech companies in a pandemic-triggered recession. If sharply rising raw material prices are the cause of the crisis, mining companies, raw material traders or mining companies may benefit greatly.
GOOD TO KNOW: If you find yourself facing financial bottlenecks, you should always talk to your bank as early as possible. Very often amicable solutions can be found – through debt rescheduling, rate adjustments or other options.
How do I prepare financially for a recession?
Many employees face short-time working or unemployment in a recession. In any case, one’s own job is no longer as secure as it was during an upswing or a boom phase. How do you best prepare financially if you are affected?
Liquidity reserve: create a liquidity buffer that you can fall back on in an emergency. For this you should choose investments that are available at any time without loss – for example overnight money.
Debt Reduction: Reduce Debt and Forego New Loans. A quick debt discharge is always a good decision; it gives yourself additional financial leeway – good if you expect a loss of income or if your income falls away.
Invest flexibly and safely: Put more emphasis on security for your systems and avoid long-term stipulations. Risk diversification is even more important than usual. Returns remain a selection criterion, but are not now top priority.