Rising interest rates, rising inflation and falling stock markets have led many to believe a recession is imminent.
The Fed in July approved raising the federal funds rate to a range of 2.25% to 2.5%, the fourth straight hike since March. U.S. inflation hit a 40-year high in 2022 as demand rose, global supply chains were already strained and Russia invaded Ukraine.
In addition, the S&P 500 had its worst start to a year since 1970, entering a bear market on June 13, 2022 after falling more than 20% from its Jan. 3, 2022 high, further exacerbating the possibility of Depressed sentiment.
If a recession hits, here are some investments to avoid.
What investments should you avoid during a recession?
Recessions can be difficult to predict and even more difficult to control. Investments that you traditionally thought were safe could put you at greater risk, depending on the economic environment.
High yield bonds
Your first instinct might be to ditch all stocks and invest in bonds, but high-yield bonds can become especially dangerous in a recession.
High-yield bonds with sub-investment-grade credit ratings are riskier than government bonds and are very vulnerable to market downturns. Issuing companies are typically smaller, more indebted and of lower overall quality, and are more likely to experience difficulties when markets are uncertain.
Stocks of Highly Leveraged Companies
During a recession, companies with large amounts of debt on their balance sheets should be avoided. A heavily indebted company is more likely to fail during a recession. When a company struggles to service its debt due to reduced demand and an overall economic slowdown, its stock price can fall quickly.
While leveraged companies may collapse in a recession and provide investment opportunities in the future, defensive investors should stay away when companies face clear business challenges.
Consumer goods company
Consumer discretionary stocks are popular in boom times, but their goods and services don’t fall under necessities like utilities and health care. Well-known consumer goods companies include Tesla and Nike.
The industry could be particularly vulnerable to recessionary pressures as the economy slows and people start spending less. Changes in consumer discretionary companies have been more dramatic as consumer sentiment and the economic cycle shift, and this situation is likely to worsen during times of financial uncertainty.
Other speculative assets
Speculative investments are high-risk, high-yield investments, such as penny stocks or emerging market stocks. Penny stocks are small companies whose shares trade at very low prices. They are usually not listed on major exchanges and often do not provide financial information, thereby creating a lack of transparency for investors and making them venture capital.
Emerging market stocks are stocks of companies in developing countries outside the United States. These countries are considered to be in growth mode and therefore risky, less transparent and politically risky. While this is not the case for all emerging markets, there are still significant risks to their status as emerging markets.
Many also consider cryptocurrencies like Bitcoin to be speculative. Cryptocurrencies are susceptible to price volatility, which can reduce returns significantly during recessions.
Which investments should investors hold?
A recession doesn’t mean you should get out of all your investments. Falling prices can offer investors the opportunity to buy valuable long-term investments at a discount. Distinguishing what to give up and what to keep investing is a crucial first step.
“In general, investors should consider balancing capital preservation in their portfolios in the short-term with maintaining investments for long-term opportunities. In this environment, the way you are exposed is critical. Sid Vaidya, Chief Investment Strategist, U.S., TD Wealth We advise investors to focus on higher quality assets and avoid more speculative areas in the market.
That means stocks are focused on companies with strong balance sheets, high-quality fixed-income securities such as government and mortgage-backed securities, and credit instruments such as investment-grade bonds, Vaidya added.
Government bonds and mortgage-backed securities are higher quality securities that provide stable income and stability.
It’s important to stay invested during a recession, not just turn your positions into cash – but the quality of your investments matters. During a recession, it’s important to avoid debt-laden companies, high-yield bonds, and speculative investments to ensure your portfolio isn’t exposed to unnecessary risk. Instead, it’s best to focus on high-quality government securities, investment-grade bonds, and companies with solid balance sheets.
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