Recessions, defined as two consecutive quarters of shrinking gross domestic product (GDP), are commonly associated with falling stock markets. However, the two don’t necessarily happen in tandem. Market selloffs typically occur well ahead of recessions being officially announced, and they often recover well in advance too. This is because economic data is largely backward-looking whereas markets tend to be forward-looking. Basing your investment decisions on what’s happening in the news right now is unlikely to reap rewards because, very often, this will have already been priced into valuations.
The most recent recession occurred in 2020, when the coronavirus pandemic sparked lockdowns in the UK and Europe. The FTSE All Share plunged in February and March, yet it wasn’t until August, when data showed GDP had fallen by 2.2% and 20.4% in the first and second quarters, that the UK was confirmed to have been in a recession. By then, the index had already bounced back and anyone who had sold out of their investments would have risked missing out on these subsequent sharp gains.
Recession or no recession, trying to time the market is almost impossible. In an ideal world, you would ‘buy the dips’; in reality, there is no way of really knowing whether the stock market has reached rock bottom and when the recovery will occur. The practice ‘buy low, sell high’ is something that only professional investors should attempt. Do it wrong and you could miss the market’s best days, ending up significantly worse off.
The following example shows the impact of missing the market’s best days on a £10,000 investment in the FTSE All Share between May 1989 and April 2022. If you kept your £10,000 invested throughout, it would have grown to £140,287 by the end of the period, assuming dividends were reinvested and before fees. However, if you tried to ‘buy low, sell high’ and missed the market’s 30 best days, your investment would have increased to just £33,872.
Rather than trying to time the market, a much better tactic is to stay focused on your long-term goals. Recessions are a normal (albeit unnerving) part of investing. It remains true that investing offers the potential for greater returns than cash over the long term.
The best way to mitigate the impact of stock market falls is to spread your money across a range of asset classes and sectors, in accordance with your needs and attitude to risk. Different asset classes and sectors tend to perform differently to one another in a range of market conditions, which can help to smooth portfolio performance over the long term. Managing a well-diversified investment portfolio on your own isn’t easy, and that’s where getting some advice can help.