The Cold Hard Truth About Economic Conditions and the Stock Market
When an investor is planning to grow their portfolio over time, they must realize that any economy—be it the U.S., Canada, Germany, or any other country in the world—goes through many business cycles. Some terms associated with these business cycles include “recession,” “recovery,” and “peak.”
In each stage of a business cycle, markets behave differently. Investors need to make sure they adjust their portfolio accordingly to minimize their risk. What may be good during times of economic prosperity may not be the best option during economic misery.
Recession simply refers to a period in a business cycle when a country experiences a downturn in its economy. Some characteristics of a recession include slowing industrial production, rising unemployment, and declining sales. A country is said to be in a recession when its gross domestic product (GDP)—what the economy produces—contracts for two consecutive quarters.
In a recession, businesses do poorly, so as a result, stock markets aren’t usually a great place to be. Think of it this way: if people don’t have jobs, will they go out and buy? Not likely. Companies’ profit margins get squeezed, and the stock market falls.
During a recession, investors need to look for safety—their losses in the stock market can add up. They may want to consider high-grade government bonds and companies with good fundamentals. Investors might also want to look at financial “safe havens,” such as gold, to protect their assets.
Recovery, or expansion, is a stage in the business cycle when things are getting better for the economy. Consumer confidence improves, businesses hire, and individuals find jobs. Consider the U.S. economy, for example. After the Great Recession, which was followed by a housing slump, unemployment decreased, consumer spending improved, and businesses showed profits.
In this stage of the business cycle, investors can profit by investing in companies that are in “producing” sectors, such as the industrial, basic material, energy, financial, health care, and consumer staples sectors. The reasoning behind this is that while an economy is in recovery, companies produce and consumers consume. So, companies involved in producing in certain sectors can offer the biggest bang for your buck.
The peak is when things start to take a turn for the worse. Consumers hold back their spending and, as a result, business activity starts to deteriorate. Economic indicators start to show dismal results, and businesses lay off their employees.
In this phase of the business cycle, investors need to be cautious, preserve capital, and not be as aggressive as they had been during the recovery phase—they need to lower risk. Consider investing in utilities companies that can benefit your portfolio. You may also want to start allocating a portion of your savings into safer places, in case economic conditions deteriorate quicker than anticipated.
Adjusting portfolio allocation according to current market conditions can result in a significantly higher gain over time. We all saw what happened during the market sell-off in 2008 and 2009; if investors didn’t adjust their portfolio and thought they could weather the storm, they got themselves in deep trouble and witnessed the shrinking of their portfolio.