The UK enters recession for the first time in 11 years
What could this mean for our wealth and are things as bad as they seem?
The word ‘unprecedented’ has been used multiple times in multiple contexts during the pandemic. Economically too, ‘unprecedented’ is the appropriate adjective.
Gross domestic product (GDP) fell 2.2% in the first quarter of 2020 (January to March), and an eye watering 20.4% in the second quarter, allowing the ominous word ‘recession’ - defined as a fall in GDP for two successive quarters - to dominate our conversations once more. It is little surprise of course as the country has effectively been shut down for months and is only starting to come out the other side as we begin to get back to the ‘new’ normal way of life.
In a recession, companies are less profitable – they pay employees and shareholders less – and jobs are cut. A shrinking economy reduces tax yield, ultimately forcing cuts to benefits, public services and public sector employee wages.
But are things as bad as they seem?
The Office for National Statistics (ONS) quotes UK growth of 8.7% in June following 1.8% growth in May. Overall, the ONS expects the UK economy to shrink by 9.5% this year, down from its previous estimate of 14%. The Bank of England states damage caused by the economic downturn will not be as potent as originally feared but reinforced that recovery would take longer.
Encouraging numbers yes, but what of the wider context?
Chancellor Rishi Sunak’s support packages impressed but furlough cannot be unlimited and cannot prevent redundancies; and you may have to forget about pay rises and promotions. Some businesses can adapt to home working, but sadly others cannot. Worst hit examples include the airline, foreign holiday & hospitality industries. The services sector - powering 80% of the UK economy - suffered the biggest quarterly decline on record. The pandemic has impacted logistics firms and supply chains trading within the UK, within Europe and beyond.
Pandemic effects on unemployment have been cushioned by the furlough scheme but for how long? Many analysts suggest this is the "lull before the storm". Time will tell shortly, as the scheme is due to be wound up in October.
What does that mean for us as savers and investors?
The economic cycle follows the trend: expansion, peak, contraction, trough.
During an expansion rising to peak, positive economic activity can be reflected in stock prices – investors can see the value of their investments rise. Conversely, during a recession (contraction) income and employment - for most - shrink together.
Recessions can come from different sources: overpriced assets of the 1999 dotcom crash, systemic malpractice creating the debt crisis of 2008 and now the external effect of a virus pandemic. During a recession, stock price volatility and falls make investors switch from risky assets and adopt a “flight to safety”, preferring defensive stock to protect capital.
This may be true for general cycles but due to incomparable central bank intervention - keeping markets liquid - investors have been able to continue trading despite strong recessionary indicators. March saw stock prices drop and therefore lower returns for investment portfolios, but they have since rallied; America’s S&P 500 (the largest US 500 companies) has recovered to pre-lockdown levels and beyond.
European stock markets have not rallied equally but there are signs of recovery. This is truly unchartered territory; economies receding without reflection in market prices. While central banks keep economies afloat asset prices will continue their growth trajectory.
Are there opportunities for investors?
Any rational commentator would predict that eventually recessionary factors must be reflected in market prices. This will certainly create opportunities for investors; in particular a “value investing” strategy, which is similar to an end of season sale - strong companies will see share prices decline and there will be bargains. These are not entirely rational times however, so we must wait to see how the recovery shapes itself.
For those looking to retire in the near future, it may be worth delaying or minimising drawing from invested pensions and drawing from your cash reserves instead, especially with current low savings rates not generating desired returns. This will allow markets to recover before spending any pension pot and help mitigate the impact of drawing from investments in a falling market - this is known as sequencing risk.
If already drawing from a pension pot(s), continuing to drawdown without review can cause lasting damage to retirement trajectories, especially if stock markets suffer substantial falls. Those withdrawing a significant amount of money from their pension during a downturn may see it struggle to recover its financial strength, as they will be selling more units to meet the monetary value desired, and therefore will miss out on larger returns from any rebound. This is due to the effect of compounding.
What the best strategy for savers?
It’s generally suggested that savers should pay off any outstanding debts; interest rates are low now, but as recession sets in, demand for borrowing increases and credit supply decreases, usually resulting in increased interest rates. Times have changed and an increase in the Bank of England base rate may not mean an increase in your savings rates sadly but will undoubtedly mean an increase in your borrowing costs such as your mortgage.
Recessions are unpredictable, they can affect the entire economy as well as closer to home in ways unimagined.
Savers are always encouraged to have cash reserves, up to 3 to 6 months’ worth of expenditure to cover any unexpected costs however we recommend anything up to three years as you really never know what is around the corner and a larger cash buffer can give you some peace of mind.
Take advantage of cheaper markets
Anyone with surplus income, it may be worth considering making a regular investment to take advantage of cheaper markets. Contributing to an investment during downturns can have a positive impact on future values (if left untouched and given significant time to grow).
For further information, please refer to “Phasing your investments, why investing isn’t an all or nothing game”, published in our TPO Insight Summer 2020 edition.
If you are an investor who would like a professional review of their portfolio or are looking to invest with a view to maximising potential upsides whilst protecting against downside risk, then do get in touch with one of our experts.
We are currently offering all those with £100,000 or more in savings, investments or pensions the opportunity for a FREE cash flow retirement review worth up to £500. Find out more.
The value of an investment and the income from it could go down as well as up. The return at the end of the investment period is not guaranteed and you may get back less than you originally invested.
The contents of this article are for information purposes only and do not constitute individual advice.