Recessions bring in hard times for a variety of sectors in an economy. The stock market is one such important segment wherein the livelihood of millions is dependent. Although stock market investments come with inherent risks involved, there sure are ways to pick secure investment options in order to ensure the maximum profit. The following article explores the impact of the recession on the stock market while focusing on some of its individual sectors for a more insightful look into the industry. Read on to learn more.
What is a Recession?
A recession is essentially a prolonged negative GDP (Gross Domestic Product) growth in an economy. It is calculated when the said negation in GDP growth continues for two consecutive quarters. In any functional economy, a period of recession is practically inevitable. The government takes steps to curb a recession by spending increases in order to ensure a fiscal stimulus. A recession is also indicated by a growth in unemployment rates. The decrease in the output of an economy is inversely proportional to the unemployment rate. Most of the world’s advanced economies expect a recession at a time period of 7-10 years.
Recession affects the business and impacts the survival of the common people. The NBER or National Bureau of Economic Research in the U.S. also includes the fluctuation in the business cycle as one of the indicators of recession, as most nations have their own way of confirming a recession.
How Does it Impact an Economy?
A recession in the economy hits the unemployment rate as its first victim. Since the business suffers heavy blows in terms of lack of capital, big businesses save their businesses by employing layoffs of the lower level employees. At the same time, small businesses are impacted on a higher level as they are growing businesses. They are hit with a stoppage of cash flow. Moreover, the clients refuse to invest in businesses that lack stability and have a liquid cash flow, which is why at the time of recession, smaller businesses often take the blow and go under.
Furthermore, in an economy, any sector that is dependent on direct consumer expenditure takes the maximum hit; these include retail and real estate; moreover, sectors that need a high amount of capital in order to function also suffer the most at times like recession, these include manufacturing and construction.
How is the Stock Market Impacted Due to a Recession?
In any situation, the stock market is usually impacted before the actual downfall of the economy and the coming of recession. The trend in the stock market is led by various factors such as the range of the bond yield, geo-political issues, inflation etc. The setbacks faced by businesses due to fewer demands and layoffs lead to a reduction in expenditure by the consumer (during a recession); this, in turn, impacts the stock market because of the increasing volatility and lowering costs.
The stock market varies from sector to sector. Therefore, at a time of recession, while there will inevitably be some sectors that will underperform, there also exist sectors that perform well even at the time of recession. These can include the healthcare and staples sectors (defensive stocks) since even at the time of economic downfall, consumers need access to healthcare and groceries during tough times as well. Two other sectors that perform better than the rest are the Value and Growth stocks of the stock market. Value stocks are a more attractive option as compared to growth stocks because of their low price range. The socks that are not prone to good performance, especially at a time of recession, include:
- Company Stocks: Since we are talking about the period of recession, several companies undergo debt or a decrease in cash flow. This is why investment in a highly- leveraged company stock is a risky option.
- Penny Stocks: Penny stocks (also known as small-cap stocks) are stocks with low prices; they are high-risk, high-return stocks. At the time of recession, however, these penny stocks can hardly be trusted due to their lack of transparency.
- Consumer Discretionary Company Stocks: These companies do not come under everyday importance and are more lifestyle and luxury-related companies. While the stocks of these companies flourish under healthy economies, they do not do so well under recession when times are tough. People cut down on expenses; hence, these companies experience low demand. These also include cyclical stocks as they include sectors such as automotive and other non-essential goods. Cyclical stocks are closely knitted with the economy; therefore, they do not perform well during a recession.
- High-Yield Bonds: High-yield bonds contain low credit ratings. They have a high-interest rate and are corporate debt securities. These bonds are hence very risky investments in times of recession.
An important thing to note while talking about the stock market impact of a recession is that not all recessions are similar, and there is no set of rules or formulas that can specifically decide how a stock may perform at the time of recession. The stock market, in its essence, is associated with risk; the goal of the buyer should be to pick their best chance of profit.
Through the above-stated information, investors can predict stock market fluctuations at the time of an economic recession. While there may be no fixed calculation to determine the outcomes of a stock market best, the general trends and analyses have been presented to the readers in this article in order to choose a secure investment option. Need more of your queries on stock markets and alternative investments answered? Head on to the Bhive platform to get the solution to all your investment-related problems.