It is becoming increasingly likely that major economies around the globe will plunge into a full-blown recession this year, the UK included.

Analysts and economists fear the global economy’s growth momentum will grind to a halt as central banks continue to raise interest rates in a desperate attempt to combat high inflation.

If the UK and other major economies do fall into recession, what can investors do to protect their investment portfolio and keep their wealth relatively intact?

In this article, Shares answers the key questions that investors may have; and offers common sense and practical actions.

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HOW SERIOUS COULD IT BE? 

ARE WE FACING A GROWTH SLOWDOWN OR AN OUTRIGHT RECESSION?

A recession is widely defined as two successive quarters of negative GDP growth, and the current signs aren’t great.

The latest data from the ONS (Office for National Statistics) reported the UK economy shrank by 0.3% in April, having declined 0.07% in March, amid soaring living costs and unprecedented fuel price rises.

The Bank of England warns the economic outlook for the UK and globally has deteriorated materially. It’s the pace of inflation that makes recession an increasingly safe bet.

In May, UK inflation hit 9.1% and is forecast to soar beyond 10% by the end of the year, according to Trading Economics. In simple terms, real GDP growth must rise faster than this amount, which is a tough ask.

Things are heating up elsewhere, too. According to forecasts from Bloomberg Economics, the chances of a US recession have risen to 38% with the latest meeting minutes from the Federal Reserve showing the central bank will do whatever it takes to tame inflation. ING analysts say the long-awaited economic recovery of the eurozone has been ‘cancelled’ as the economic data worsens.

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Further evidence comes from oil prices, which correlate with economic prosperity. Having rallied hard earlier this year, Brent Crude prices have fallen 15% since the start of June.

HOW HAVE MARKETS PERFORMED DURING PREVIOUS RECESSIONS?

Using the S&P 500 as an illustration, equities have performed surprisingly well during recessions, rising an average of around 1% during all recession periods since 1945, according to CFRA Research.

This is because stock markets are forward-looking and tend to price in economic downturns long before they happen, and subsequently pricing recovery early.

During the last four recessions since 1990, the S&P 500 declined an average of 8.8%, says the CFRA study, yet in more than half of the 13 years with recessions since World War II, the S&P 500 has posted positive returns.

‘When we do finally fall into a recession, that’s usually a good time to get back into the market,’ says Sam Stovall, chief investment strategist for CFRA Research.

Economic downturns do not last forever so if you have an investment horizon of five years or more, you should be able to benefit from market recovery by sitting tight and staying invested.

Share prices have delivered higher returns than cash deposits in over 76% of all the five-year periods since 1899, according to the Barclays Equity Gilt Study. [SF]

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WHAT DO I DO WITH MY PORTFOLIO?

DON’T PANIC SELL

Markets are forward-looking and this year have been pricing in the risk of a recession long before we find out if it has happened.

Unless you desperately need the cash to pay essential bills, there is no merit in selling investments now. So much bad news is already in the price of stocks and funds.

If you are still in the wealth accumulation phase of your life, sit tight and ride out the bad patch.

For those already in retirement, it’s important to review your portfolio and check you are happy with the risks being taken. If you don’t already have a diversified portfolio, now is the time to build a plan.

You may want to take some profits in your best performing holdings and use the proceeds to build new positions elsewhere to help diversify.

DRIP FEED MONEY INTO THE MARKETS

History suggests it is perfectly normal for recessions to happen – economies go through good and bad cycles, and the patient investor should simply sit tight and continue to feed their ISA or pension.

Putting money into your investment account each month means you pay a lower price to buy a share or fund unit when markets are down and a higher price when they’re up. You’re not trying to time the market.

Having a regular savings habit is one of the key stepping-stones to being financially fit later in life. Sort out a direct debit to fund your ISA or SIPP (self-invested personal pension) each month and then set up a regular investment into a broad investment fund. By doing so, you also take the hassle out of investing and having to remember to do it. [DC]

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I’M HAPPY TO KEEP INVESTING. WHERE SHOULD I LOOK?

DEFENSIVE STOCKS: SURE-FIRE WINNERS? TOO LATE TO BUY? NOT AS SAFE AS YOU THINK?

An obvious place for people to invest against a difficult economic and market backdrop is in traditionally defensive sectors like utilities, tobacco, consumer staples and healthcare.

They sell products which people buy in both good and bad economic conditions, which makes their earnings less volatile. However, not all such investments have delivered in 2022.

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Unilever (ULVR), for example, may sell household essentials but it has struggled to pass on rising input costs to customers and its shares were struggling before the recent intervention of activist investor Nelson Peltz.

Other areas have already performed well, like electric utilities and tobacco stocks. The former have been supported by strong energy prices and share valuations now look more demanding.

Tobacco stocks still look reasonably cheap and offer generous yields. Investors face a judgement call on whether their short-term attractions outweigh longer term risks. Because they are addictive, people tend to buy cigarettes even if prices rise materially, so companies like British American Tobacco (BATS) and Imperial Brands (IMB) are generating lots of cash.

However, longer term there is a threat from increased regulation in the tobacco sector.

The healthcare sector is possibly the best place to look for a defensive investment at present. Valuations have, for the most part, not run away with themselves.

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A sensible option for investors would be investment trust Polar Capital Global Healthcare (PCGH) which trades at a discount to net asset value of 7.8% and has an ongoing charge of 0.83%. Its portfolio includes stakes in such companies as Johnson & Johnson (JNJ:NYSE), Novartis (NOVN:SWX), Boston Scientific (BSX:NYSE) and AstraZeneca (AZN).

UNCORRELATED ASSETS: WHICH ONES LOOK GOOD?

In a world where both bonds and shares are performing poorly at the same time, investors may have to look outside these two mainstream asset classes if they want to protect their returns.

Uncorrelated assets such as infrastructure, real estate and even more esoteric options like music royalty funds are potential options for anyone looking to put money into an investment that should hopefully not move in line with stock markets. It’s good to have some of these in your portfolio to make it truly diversified.

For example, infrastructure projects are very long term in nature. They often deliver income streams over many decades and short-term fluctuations in the wider market should have limited impact on valuations and returns.

A low-cost and straightforward way of gaining exposure to infrastructure is to buy shares in iShares Global Infrastructure ETF (INFR). The exchange-traded fund, which has an ongoing charge of 0.65%, can be bought and sold in the same way as an ordinary share.

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It pays a quarterly dividend and offers a modest yield of 2.3%. Performance over the last year has been impressive given the backdrop at 15.5% and on a 10-year view it has delivered an annualised return of 7%. [TS]

BONDS: GOOD OR BAD?

Bonds haven’t provided their usual historical diversification benefit over the last year with government bond prices suffering some of their biggest falls in decades.

This is due to surging inflation and rising interest rates which have pushed US 10-year government bond yields up from 1.2% to over 3% over the last year. As bond yields go up, the price comes down.

Yields on corporate bonds have increased at an even faster rate.

If the US central bank causes a recession by pushing interest rates up too far in the face of a softening economy, prices of government bonds and high-quality corporate bonds should increase as yields fall.

This should allow bonds to re-establish their historical relationship with equities and provide stability to investor portfolios.

A good way to play a potential fall in bond yields is through the Allianz Strategic Bond Fund (FUND:BYT2QW81) which specifically targets a low correlation with equities. [MGam]

CAPITAL PRESERVATION FUNDS: ARE THEY SIMPLY ABOUT PROTECTION OR CAN I MAKE MONEY FROM THEM?

Yes, you can make money from them, with some of the most popular options with investors having historically delivered between 6% and 12% a year on average, well above trailing inflation.

Maintaining this performance in a much higher inflation environment might be a tall order and could see these typically conservative investment strategies embrace modestly higher risk in the short-term.

Capital preservation strategies have pulled in investors this year as major global stock markets have fallen, yet the likes of Capital Gearing Trust (CGT), Personal Assets Trust (PNL) and Ruffer Investment Company (RICA) continue to trade within their typical share price to assets range, roughly a couple of percentage points either way.

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On balance, Capital Gearing is our pick of the bunch, with a portfolio widely spread over property, infrastructure, bonds and equities. It sensibly uses low-cost ETFs to access overseas stocks, where it likes Japan and Europe right now.

Averaging a 7% annual return over the past decade, Capital Gearing has one of the sector’s lowest charges at 0.5%. [SF]

HIGH YIELD STOCKS: WHICH ARE THE SAFEST AND WHY IS INCOME A SAVIOUR DURING A RECESSION?

In a recession, dividends are an important a source of positive returns for investors.

Unfortunately, dividends often get cut when times get tough and company revenues and cash flows fall. Therefore, it can be misleading to look at the highest yielding shares without also considering the financial strength of a company and if it is sensitive to the state of the economy.

A simple way to gauge the sustainability of the dividend is to see if earnings are much larger than dividends payments. A ratio greater than two implies a company is only paying less than half of its earnings as income to investors, which means the dividend should still be affordable even if earnings decline.

Companies which have more stable revenues, such as utilities, are not immune to recession. Yet their earnings are likely to hold up better in an economic downturn because they provide non-discretionary services.

A great way to achieve diversified exposure to high yield stocks and reduce the risk of picking the wrong shares is to invest in a high-yielding fund.

Shares believes Merchants Trust (MRCH) fits this objective very well. The investment trust offers a dividend yield of 5.1% and has delivered 40 consecutive years of rising dividends. It trades at a small premium (1.2%) to net asset value and has an ongoing charge of 0.55% a year. That’s relatively low-cost for an actively managed fund. [MGam] 

LOOK AT GOOD COMPANIES THAT ARE NOW A LOT CHEAPER

Bear markets have a habit of dragging nearly everything down in price. That provides an opportunity to buy shares in good companies at a cheaper level than last year.

Yes, near-term earnings might take a small hit, but investing is about focusing on the long-term opportunities and there are plenty of quality companies on the stock market which should bounce back quickly once recession plays out.

Supplying some of the slickest must-have tech gadgets on earth has allowed Apple (AAPL:NASDAQ) to build a walled garden ecosystem that millions of users find to be an absolute necessity in today’s digital-first age. That means enormous cash flows and reliable growth for Apple which translates into growing dividends for its shareholders.

Two years ago, the stock traded on 36 times forward earnings. Today that price to earnings or PE ratio is now only 23.3, which is essentially like saying the company has a ‘35% off’ sticker.

Some investors may argue it was previously overpriced and that might be a fair point. Yet the current valuation looks appetising given the company has all the right qualities to prosper over the long term.

Apple’s shares are worth buying now and tucking away. However, there is a caveat. Prospective investors must recognise that market sentiment towards the stock could remain fragile in the short-term, particularly if there are signs that consumers are radically cutting back on spending. [SF]

WHY COMPLICATE THINGS? TAKE THIS SIMPLE INVESTMENT APPROACH

There’s a lot to be said for keeping things simple in life and that extends to investing. Not everyone wants to spend hours looking at share price charts and financial reports, trying to work out what to buy and sell depending on the state of the economy.

If that resonates with you, there is a stress-free way of making sure money goes into your investment account and it only takes as long as boiling the kettle for a cuppa to set up. Once done, you can go and live your life and not worry each day about what’s happening to your ISA or pension.

The trick is to invest in stocks and shares from around the world and a mixture of government and corporate bonds. To make life even simpler, you can buy a single investment product that has all those things under one roof such as Vanguard LifeStrategy.

There are five versions of this fund which come with different weightings of stocks and bonds. If you’re saving for retirement and have at least five years left in full-time work, you may like Vanguard LifeStrategy 80% (B4PQW15). The 80% refers to the weighting of assets in shares and the remaining 20% held in bonds. It comes with a low charge of 0.22% a year. 

Set up a direct debit to feed your investment account with cash each month, then sort out a regular investment in the Vanguard fund. After that, all the investing is automated, so you don’t have to do anything else. [DC]

DISCLAIMER: Editor Daniel Coatsworth owns shares in iShares Global Infrastructure ETF.

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