Mention the r-word – ‘recession’ – and watch Wall Street break out in a cold sweat as investors and traders alike start waving big red flags.

Seriously, am I the only kidult here that’s seen the Lion King?

Stocks jumped everywhere last week, despite news that the US economy has now contracted for two consecutive quarters – that’s a recession, BTW.

With consumer confidence at – well, recessionary – lows the combination of commercial cholesterol, cost-of-living pressures, sharp interest rate hikes and a global downturn point to a bit of a potential minor stroke or perhaps just a mini-embolism for the Aussie economy next year.

As the world comes to grips with the ripple effect of COVID-19 and global headwinds wreak havoc with consumer behaviour, it pays to stay one step ahead when markets dip. And, it’s not all bad if you’ve wolf-proofed your house and don’t mind that the bears have come to stay.

Because this is when the bears take over the lease from the bulls, who’ve dug a shallow hole in which they pretend to hibernate, but actually keep popping up to sporadically buy stuff.  Everyone else is protecting the portfolio.

Recessions or their imminent arrival – as one could argue we’ve been seeing all year –  often cause sensible people to lose their s..t, the neighborhood to there goes and equity markets to become more volatile, representing opportunities for traders and investors who are aware of the risks.

So what is a recession anyway and should I buy a gun?

It’s a stretch of slower economic growth. That’s it. End of story.  

I know the way we say it on TV makes it sound a lot more like a lifetime of nightly Elton John duets in Concert, but even speaking technically, ’tis but  two straight quarters of negative GDP (gross domestic product) growth.

Equity markets will generally take one or two on the chin during this time, says legendary CMC Market’s senior analyst APAC & CANADA, Azeem Sheriff.

“You can often see its effect in reduced household and business expenditure, reduced demand for debt, and a rise in unemployment.”

But recessions can offer all sorts of opportunity for those little pigs safe from the wolf and living uneasily from day to day between the bears and bulls.

Proactive investors (that’s you BTW) can take all sorts of moves to ensure the portfolio is diverse and robust, while some of the sell-offs we’ve already been enjoying lead to bargains for the bullish buyers hidden under the topsoil of one’s commercial spirit.

And while a really solid recessions can wreak all sorts of havoc on the country, economy and the soon-to-be-ex-government, they’re actually a natural and – as it happens – necessary part of the business cycle…. economies grow until they reach a bit of a peak, and then contract until they hit a trough before expanding once again.

Take it from the classically educated Hans Gruber (Die Hard, McTiernan 1988).

Gruber: All of you relax. This is a matter of inconvenient timing — that’s all. Police action was inevitable, and… as it happens, necessary. So let them fumble about outside, and stay calm.

And here’s a drawing a small child made of a country’s (let’s call it Gruberland) economic cycle.

The Economic Cycle: New theme park ride opens for summer

recession 2022
Via IG Markets

Your recession ladies and gents (as seen above) is when it’s going from the peak to the trough.

How does a recession impact markets?

Equity markets tend to decline rapidly during a recession. Like guns, currencies are volatile, commodity prices fluctuate, investor sentiment is low and people just change, man.

Most investors and companies tend to be risk averse, says Azeem.

“Investors will pivot from riskier assets — think cryptocurrencies and Information Technology — to safer ones as such as bonds, gold and consumer staples. This sees risk asset prices drop and performance rise for asset classes with lower but stable returns, having less reliance on economic cycles.”

Here are the dos and don’ts, sector wise

Just cut around the dotted recession and pin it up on your digital wall.

recession 2022
Via IG Markets

 

Azeem’s stocks and sectors to watch

Azeem says diversifying your portfolio is one way to stay in the green as markets fluctuate over time. 

“Spread your risk across a variety of share types for the best chance to navigate bumpy markets successfully.”

Here’s your match day team list, we’ll go through them:

recession 2022
Via CMC Markets

 

Defensive stocks

“These tend to weather economic cycles well because they resist the changes in consumer demand that comes with a recession,” Azeem says.

“You’ll find them in industries considered ‘necessary’ in any economic event, offering goods and services we always need. They offer stability and consistent dividends with low capital growth.”

 

recession 2022
Via Christian and Microsoft

 

Eddy would go

recession 2022
Via eddiewouldgo.com

One particular niche industry – adored by goths, and apt to perform during the next pandemic – is among the defensive plays which our Fearless Eddy ‘Would Go’ Sunarto sometimes tracks and which he notes is facing some very favourable tailwinds – “characterised by low competition, high margins and returning customers (though, very rarely the same ones).”

Death and Recessions

The global funeral industry is relatively recession proof, although some customers may opt for lower-cost services, Eddy notes.

“Inflation could also squeeze margins slightly and unlike tech stocks, funeral stocks are mainly valued on existing cashflows.”

Eddy gets into it here in some glorious gothic detail. Again, worth a peek.

As but a taste, NYSE-listed Service Corporation International (SCI) is the biggest provider of funerals and cemetery services in North America.

Needless to say, SCI did very well during the pandemic.

And these are nice numbers too:

Source: Google

 

Blue chip stocks

As the only adult in the newsroom,  Eddy also points out that during this time of magical market mystery, blue chip Energy and Mining stocks provide decent dividends that outmatch the CPI rate.

In the last financial year, BHP paid close to a 12% dividend yield, while coal stock New Hope (ASX:NHC) paid around 8%. Talking of divvies, he’s knocked up a pretty decent list of small caps paying out, here.

Azeem, meanwhile, says your garden variety ASX Blue Chip stock has “generally seen it all” in terms of economic cycles.

These are the ones Azeem likes. “Dependable earnings, solid financials”

Via CCE and computers (and if anyone here writes me about the random cursor I will go into recession myself) 

“They hail from large corporations that are well-established, financially stable and market leading. They often have dependable earnings with solid financials and stability including consistent dividends,” Azeem adds.

“It’s your safest equity haven, largely considered to be the go-to/low-risk/more reliable option for investors.”

Woodside Energy (ASX:WDS)

According to Barclay Pearce Capital equities trader, Morgan McGuire, Woodside has conventional, low-cost assets that are technically simple to operate.

“Around 95% of their production is in OECD jurisdictions and they produce 70% gas, which is increasing over time.

“The company has also recently merged with BHP Petroleum business to create a larger and more financially strong global energy company via an all-stock merger into Woodside Energy of BHP Petroleum.

“WDS has reported FY21 underlying NPAT of US$1.62B, which compares to market expectations of US$1.45B – however, the FY22 guidance is in line with current market expectations.”

McGuire’s other choices for troubled times include Pilbara (ASX:PLS) and Northern Star (ASX:NST).

 

 

Growth stocks

“These are shares with significant growth potential. Investors generally buy them for capital growth, not dividends. Growth stocks typically don’t pay dividends to investors as they reinvest their profits back into company development,” Azeem notes.

“Growth stocks tend not to fare well during a recession because they strongly rely on high product demand from consumers and estimated future cash flows.”

Via Azeem

 

Cyclical stocks

The Sheriff says cyclical stocks tend to be hit badly during recessions.

“These companies and sectors tend to be sensitive to the contemporary economic climate – meaning they tend to increase when markets are on the rise, and decrease when markets are on the fall. 

“Cyclical stocks are sensitive to economic change. They tend to dip in value during a recession due to reduced consumer demand, but they also offer an opportunity to buy undervalued stocks. That’s because investors will often look to sell these stocks during a recession, out of fear or profit taking, providing an opportunity for new investors to enter these markets.”

So, during recessions when markets are falling, cyclical stocks could present good opportunities to go short.

Via Azeem Sheriff and good people at CMC

 

What not to do in a recession:

Azeem says:

  • Predict the bottom. Nobody knows when the market will pivot. Don’t get caught trying to time the market with fear of missing out. Time in the market is more important than timing the market.

  • Panic sell. Don’t let your emotions take control of investing decisions. Keep the general economic cycle in mind and the reasons behind your initial investment. Consider all your options, have confidence/conviction in your research and let the company ride the economic wave.

  • Get caught in the white noise. It’s not uncommon for investors to turn to short-term speculation for quick profits. If you’re considering trading short-term price movements during a recession, ensure it suits your personal financial goals and you’re set with a strategy and understanding of the risks involved.

 

Trading during a recession:

Azeem reckons there’s market potential to find using the following trading strategies:

Dollar-cost averaging

Consider investing certain amounts of money at incremental intervals instead of keeping all your eggs in one basket (at one price). As the share price falls, you buy more equity, reducing the average buy price of the share over time. Always do your research to make sure there’s future growth in your chosen share.

Exchange Traded Funds (ETFs)

Exchange Traded Funds (ETFs) are a basket of securities or pooled investment vehicles that typically track a particular index, commodity, sector or asset. You can partially own an ETF, providing you with diversified exposure to the basket of assets in that ETF without actually owning the whole underlying assets like shares.

Options trading

Pay a premium for the right, but not obligation, to buy or sell shares at a specific price or on/by a specific date. Options trading is like a form of insurance should the market not work in your favour.

However, options contracts, especially short options positions, carry different risks than shares and are often intended for more experienced investors, for example, margins and expires. learn more

Share CFD trading

CFD trading is fast-moving, the higher volatility creates both risks and opportunities.

Trade rising and falling markets with Share CFDs. By taking a short position on the price movement of a share, you can potentially hedge the loss of a long-term investment without owning the underlying share.

While CFDs offer an alternative to trading volatile markets where you can also profit from falling markets, they also present potential pitfalls. 

Investors should be aware of the significant risks, and costs associated with CFDs.

Why we WILL be having a recession:

Platinum Asset Management has said quite clearly that what’s happening right now “does not look like a ‘garden variety’ bear market”.

Julian McCormack from Platinum believes investors should be aware that what is happening right now is “the implosion of one of the great equity market bubbles of all time in the US.”

In Platinum’s view, markets are some way toward correcting the worst valuation excesses of the “everything bubble”.

Investors must now deal with what McCormack says is “very likely damage to the real economy in the US, and consequent impairment of company earnings.”

“Note that Australian equities, like most of the world, have done little over the course of ‘the everything bubble’. The S&P/ASX 200 Index is roughly where it was 15 years ago.”

US equities on the other hand, have outperformed the rest of the world by more than 250% cumulatively over the last decade

“For a major market to achieve this is quite extraordinary in modern market history, surpassed only by Japan’s outperformance of the 1980s in our reckoning. Platinum views a repeat of US outperformance in the next market cycle to be unlikely,” McCormack notes.

Platinum expects the S&P 500 Index (a key barometer of US shares) to be down perhaps 50% from its peak. The Nasdaq (a barometer of US tech) could fall more.

The period 2000-2002 is a reasonable reference point:

Via Stockcharts (not my best)

During the course of the Dotcom Crash, which ran from March 2000 to October 2002, the Nasdaq Composite plummeted by 78%, and the S&P 500 Index (SPX) shed 49% of its value.

But it’s also worth noting Australian equities fell circa  17% during the Tech Wreck this year. US markets halved.

“When you don’t get to party too hard, you avoid much of the hangover,” McCormack says.

Platinum believes it is unlikely there will be a bottom reached in global equities for quite some time – bear markets take years, not months.

Why we WON’T be having a recession:

Ghastly stuff.

However, there are several reasons why Australia should be able to avoid a recession: the business investment outlook is solid; there’s a large pipeline of homebuilding work; high energy prices boost national income; the $A will fall if the global economy gets too weak; immigration is rebounding; inflation may be less of a problem in Australia; and the RBA has moved into the more cautious lane on rate hikes. In short.