Thinking about investing in a recession?
There are growing fears that the US economy is headed into a recession.
A succession of interest rate hikes, (the last 2 being 75 basis points each) to tame a raging inflation, have prompted analysts to believe that the Federal Reserve could steer the economy into recession. These fears have been cemented with negative GDP growth in two successive quarters.
As expected, stock investors have been reviewing their positions and making adjustments to their portfolios to hedge against possible recession. This has sparked a series of massive sell-offs in the market which resulted in the worst-half year for US indexes in 50 years.
One area which has been battered by bearish moves in the market is technology stocks. The sector has witnessed the worst one-day drops in the market. Netflix, Snap, and Meta plummeted by over 25% in a single day. The Nasdaq, an index overweight with tech stocks, also led US equities into a bear market.
As such, due to the much-envisaged recession, tech stocks have lost their appeal among investors - a stark contrast to the last two years when they led the bull market.
So what makes tech stocks such a risky bet in a recession? This article highlights some of the reasons why you are better off without tech stocks in a recession.
A recession refers to a period of declining GDP and is generally defined as a sustained decline for two or more consecutive quarters. Recessions are characterized by economic downturns such as widespread job losses, fewer available jobs, and more government relief to stimulate spending.
The current recession in the US is markedly different from textbook examples. Low unemployment numbers, record job openings, and increased consumer spending despite the suspension of the relief programs indicate that the economy is strong.
However, inflation at a 4-decade high has prompted the Federal Reserve to hike interest rates to the range of 2.5 to 3%. Many believe that the flurry of rate hikes has steered the US economy into a (technical) recession.
With this in mind, you may be wondering if investing in tech stocks is a good idea. Let's look at some reasons why this is not a good move.
Technology stocks are growth stocks, which means the management invests the money for the growth of the business rather than distributing it as dividends among shareholders. During a recession, when monetary circulation is tight, this would affect the growth of the company as it would struggle to sustain profitability.
Most tech companies trade on high forward multiples due to the discounted cash flow used by analysts.
This implies most of their future earnings have been priced into their stocks. This suggests that investors are investing based on their prospects and not what they can offer presently.
During a recession, when money supply is tight, investors would prefer to invest in profitable companies rather than companies that are not yet making a profit and burning a lot of cash.
Stocks generally are regarded as risk assets, but technology stocks are high up the spectrum of that cadre due to their valuations which are based on future earnings.
During a recession, when money supply is tight, and pessimism is high, investors dump risk assets in favor of other assets like gold or bonds which can preserve their wealth.
The tech sector is inundated with start-ups with lots of prospects but weak balance sheets.
This is the reason why they trade at high future earnings (as explained above). However, weak balance sheets are a massive source of headwind during a recession when companies would be dipping into their cash reserves to keep the business afloat.
Because they are growth stocks, whose valuation is based on future earnings, a bulk of tech stocks tend to be speculative. In times of economic pain, throwing money into often highly speculative risk assets isn’t most investors’ idea of a wise move.
Instead, many are looking to “safe-haven assets” to protect their portfolios, as evidenced by the outperformance of value stocks and soaring demand for gold in the first quarter. That’s bad news for the tech sector.
A recession is a period of low money circulation and negative economic growth.
As such, people will be pinching their pennies and be less inclined to take risks with their money. However, the realities of the modern world suggest that people would still have to spend money whatever the economic condition. As such, some companies would fare better than others.
Here's a look at sectors in which you should invest during a recession.
Health is important no matter the economic cycle, with its expenses non-negotiable since it directly impacts your life.
As such, stocks in the healthcare sector are less impacted during recessions than other sectors where spending is discretionary.
There are certain items people can't live without - food, toiletries and household products. This is why they are called staples. People have to eat even in a bad economy. The only difference is eating habits may change to less expensive food types.
Likewise, people need to take care of their hygiene or buy household items. As such, during a recession, companies that manufacture and sell these products usually have a steady stream of patronage.
The only difference is that buying patterns will change. For example, customers may go for less pricey brands when shopping.
Utilities are what keep our societies functioning.
Without them, there would be chaos of unimaginable proportions. Imagine if you had no water, electricity, or gas. As such, utilities are an essential part of our lives. This is why utility companies are resilient during recessions and generate constant income despite the economic downturn.
Consumers are usually mindful of their spending during recessions.
As a result, they tend to shift towards less expensive alternatives. Many people begin buying lower-priced items.
Companies that operate a chain of low-end retail stores benefit from recessions because consumers are more conscious of how much they spend, rather than the quality of the product which is the case during periods of economic growth.
Recessions test the mettle of investors and separate the strong companies from the weak. But those who make it through to the other side face less competition, paving the way for massive upside during the next boom.
Tech stocks usually take the full brunt of investors during a recession due to their speculative nature driven by forward earnings rather than present profitability.
As such, unless you have diamond hands or a heart of steel with a long-term view on your stock investment, tech stocks are not the place to be during a recession.
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