We don't know yet whether the UK is going to have a recession, or merely a sharp slowdown in growth, but either way the classic protective measures for stock market investors are the same.
It's obvious, but worth saying, that almost all recessions are preceded by a 'bear' market in shares, that is a protracted fall in prices of at least 20% from the peak to the trough. That would mean the FTSE 100 touching 5300 or below at some point, which is only just below the lows reached today.
I warned of troubled times in May last year
These are some of the classic measures to protect your capital, which is above all what an investor needs to do in turbulent times.
It's obvious, but worth saying, that almost all recessions are preceded by a 'bear' market in shares, that is a protracted fall in prices of at least 20% from the peak to the trough. That would mean the FTSE 100 touching 5300 or below at some point, which is only just below the lows reached today.
I warned of troubled times in May last year
These are some of the classic measures to protect your capital, which is above all what an investor needs to do in turbulent times.
- To keep plenty of your investable resources in cash
- To minimise your exposure to risk and uncertainty
- Not to invest with borrowed money (not that this is ever a great idea)
- To sell quickly those shares which look vulnerable to a slowing economy, preferably before your fears are proved right
- Where you have exposures you cannot control, hedge them
- To refrain from buying all but the most robust and defensive shares
- Once the financial hatches are battened down, don't fret
- Look for bargains, but not too soon
Let's deal with each of these in turn.
1. Cash
Cash is quite simply the easiest way to ride out a recession. If you haven't yet started investing, this certainly isn't the time to begin. Deferring buying shares until the economic situation is clearer and improved is an easy choice. If you want the experience, try investing imaginary money instead and see how you do. It's fun to be a pretend millionaire.
For those who are already invested, turning some holdings into cash gives you flexibility and peace of mind. That should mean first selling a proportion of your worst-performing shares, and even some that have gone sideways. Cash on hand will be available to fund bargains when prices are much lower than they are today.
One final thing: since the Northern Rock saga reminded us that banks are more frail than we imagined, you might want to make sure that any cash that exceeds the current £35,000 guarantee limit is spread among several banks or building societies.
2. Minimise risk
This is easily said, of course. Risk and reward are opposite sides of the same coin, and some of the best-performing shares are also the riskiest. However, the nervousness caused by fears of recession changes the balance of probabilities here and not in the shareholder's favour.
Some shares will always rise, even in a recession. But there will be fewer of them. Those that fall will drop further, more easily and faster. Bad news gains more credence, while good news often becomes an opportunity to take profits. These factors are most powerful on the smallest and least well-understood shares in the market where even small trades can move prices.
3. Don't borrow to invest
This is rarely a good idea in financial markets because it magnifies both risk and reward. When markets are nervous, it can be quite hair-raising. That doesn't just apply to going 'long' (buying) through spread-betting or contracts for differences, but also to borrowing money to buy shares in your employer because they seem cheap, or deciding that now is a great time to borrow to become a buy-to-let investor.
Even when borrowings are strictly controlled you have to deduct interest you would pay from any returns you might receive. If those returns are in any doubt (as is certainly the case in buy-to-let for those starting out now), it's best not to stretch your finances going for them.
4. Selling and hedging
Of all the many parts of the craft of investing, selling is probably the hardest because we get emotionally hung-up on prices: the price we bought at (how painful to sell below that), the peak price we could have sold at a few weeks ago (how mesmerising but pointless to wallow in it) and the price we imagine that this beloved share could return to, with just a little luck and patience.
The truth is that the one price we find it hardest to see is how low a share can go at the depths of a bear market. If a firm trades on a P/E of 20 and makes 2p per share in earnings, its shares will be at 40p. A halving in profits to 1p and a halving in the P/E it is accorded by the market to 10 will send the share price down by 75% to 10p.
This kind of savage de-rating has been the undoing of many a former stock market star, from Marconi to Jarvis. Once a company starts to get into trouble, seIling is essential. If it hasn't yet, but is vulnerable to a recession, selling some is advisable. The earlier you do it, the less painful it will be.
Sometimes you cannot get rid of an exposure. You may have just bought a buy-to-let property, or you are halfway through a Save As You Earn options contract with your employer.
Hedging is now fairly simple. If you are worried that the value of your investment may fall you can take an opposite position, by 'shorting' (selling, even though you do not own) an equivalent security for a period. For a house, you might choose a down bet on the appropriate regional housing index, through a spread-betting firm.
Whichever way prices subsequently move, you profit on one position and lose on the other, thus hedging your bets.
Hedging share options would work in the same way, by going 'short' on a CFD or spread-bet of the same stock that you have options over. Of course if the options have matured and been exercised, you have all the freedom of a shareholder to sell or retain them.
Spread-betting explained
5. Defensive behaviour
You have no need to turn everything out of your share portfolio. Indeed, far from it. Some companies are reliable earners, whether there is a recession or not. Tobacco, food, supermarkets, utilities and drug firms are classic examples.
Although few (except perhaps big pharmaceuticals) are currently cheap on fundamental grounds, investors seeking safety do tend to push the prices up further, the worse the economic news gets.
6. Don't fret
Once you have in your portfolio plenty of cash, some hedges where required (even gold and inflation-linked bonds can do a good hedging job) and the kind of shares you are confident to hold, you can just relax.
Screens can be anxiety-making. Seeing what prices are on offer on the worst days can turn the strongest stomachs. Once you are confident that you have the right investments, you can ignore the price that others are offering.
As legendary investor Warren Buffett said: "For some reason people take their cues from price action, rather than from value. Price is what you pay. Value is what you get."
7. Bargains
Once a recession or bear market has run its course it is time to look for bargains. How do you know when is the right time? There is no precise guide, but markets often bottom out after re-testing a low point which is some weeks after the first low.
Chartists, those investors and traders who rely predominantly on looking at price movement to predict good times to buy and sell, have a great deal more to say on this subject.
Suffice to say that how soon you buy is down to your own level of comfort with risk, but the cautious investor might like to see markets rise 5-10% from the lows to be sure that this isn't a false signal. Snapping up bargains gradually rather than all at once can provide some further comfort.
1. Cash
Cash is quite simply the easiest way to ride out a recession. If you haven't yet started investing, this certainly isn't the time to begin. Deferring buying shares until the economic situation is clearer and improved is an easy choice. If you want the experience, try investing imaginary money instead and see how you do. It's fun to be a pretend millionaire.
For those who are already invested, turning some holdings into cash gives you flexibility and peace of mind. That should mean first selling a proportion of your worst-performing shares, and even some that have gone sideways. Cash on hand will be available to fund bargains when prices are much lower than they are today.
One final thing: since the Northern Rock saga reminded us that banks are more frail than we imagined, you might want to make sure that any cash that exceeds the current £35,000 guarantee limit is spread among several banks or building societies.
2. Minimise risk
This is easily said, of course. Risk and reward are opposite sides of the same coin, and some of the best-performing shares are also the riskiest. However, the nervousness caused by fears of recession changes the balance of probabilities here and not in the shareholder's favour.
Some shares will always rise, even in a recession. But there will be fewer of them. Those that fall will drop further, more easily and faster. Bad news gains more credence, while good news often becomes an opportunity to take profits. These factors are most powerful on the smallest and least well-understood shares in the market where even small trades can move prices.
3. Don't borrow to invest
This is rarely a good idea in financial markets because it magnifies both risk and reward. When markets are nervous, it can be quite hair-raising. That doesn't just apply to going 'long' (buying) through spread-betting or contracts for differences, but also to borrowing money to buy shares in your employer because they seem cheap, or deciding that now is a great time to borrow to become a buy-to-let investor.
Even when borrowings are strictly controlled you have to deduct interest you would pay from any returns you might receive. If those returns are in any doubt (as is certainly the case in buy-to-let for those starting out now), it's best not to stretch your finances going for them.
4. Selling and hedging
Of all the many parts of the craft of investing, selling is probably the hardest because we get emotionally hung-up on prices: the price we bought at (how painful to sell below that), the peak price we could have sold at a few weeks ago (how mesmerising but pointless to wallow in it) and the price we imagine that this beloved share could return to, with just a little luck and patience.
The truth is that the one price we find it hardest to see is how low a share can go at the depths of a bear market. If a firm trades on a P/E of 20 and makes 2p per share in earnings, its shares will be at 40p. A halving in profits to 1p and a halving in the P/E it is accorded by the market to 10 will send the share price down by 75% to 10p.
This kind of savage de-rating has been the undoing of many a former stock market star, from Marconi to Jarvis. Once a company starts to get into trouble, seIling is essential. If it hasn't yet, but is vulnerable to a recession, selling some is advisable. The earlier you do it, the less painful it will be.
Sometimes you cannot get rid of an exposure. You may have just bought a buy-to-let property, or you are halfway through a Save As You Earn options contract with your employer.
Hedging is now fairly simple. If you are worried that the value of your investment may fall you can take an opposite position, by 'shorting' (selling, even though you do not own) an equivalent security for a period. For a house, you might choose a down bet on the appropriate regional housing index, through a spread-betting firm.
Whichever way prices subsequently move, you profit on one position and lose on the other, thus hedging your bets.
Hedging share options would work in the same way, by going 'short' on a CFD or spread-bet of the same stock that you have options over. Of course if the options have matured and been exercised, you have all the freedom of a shareholder to sell or retain them.
Spread-betting explained
5. Defensive behaviour
You have no need to turn everything out of your share portfolio. Indeed, far from it. Some companies are reliable earners, whether there is a recession or not. Tobacco, food, supermarkets, utilities and drug firms are classic examples.
Although few (except perhaps big pharmaceuticals) are currently cheap on fundamental grounds, investors seeking safety do tend to push the prices up further, the worse the economic news gets.
6. Don't fret
Once you have in your portfolio plenty of cash, some hedges where required (even gold and inflation-linked bonds can do a good hedging job) and the kind of shares you are confident to hold, you can just relax.
Screens can be anxiety-making. Seeing what prices are on offer on the worst days can turn the strongest stomachs. Once you are confident that you have the right investments, you can ignore the price that others are offering.
As legendary investor Warren Buffett said: "For some reason people take their cues from price action, rather than from value. Price is what you pay. Value is what you get."
7. Bargains
Once a recession or bear market has run its course it is time to look for bargains. How do you know when is the right time? There is no precise guide, but markets often bottom out after re-testing a low point which is some weeks after the first low.
Chartists, those investors and traders who rely predominantly on looking at price movement to predict good times to buy and sell, have a great deal more to say on this subject.
Suffice to say that how soon you buy is down to your own level of comfort with risk, but the cautious investor might like to see markets rise 5-10% from the lows to be sure that this isn't a false signal. Snapping up bargains gradually rather than all at once can provide some further comfort.
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