Since the financial markets are a universe of anticipation, a recession very often becomes an opportunity to reposition portfolios according to an upturn in economic activity.
2022 has been one of the worst years for financial markets, with stocks and bonds falling simultaneously. But yesterday’s losers could be tomorrow’s winners. Especially since the fall in prices last year was more due to the increase in interest rates than to the decline in corporate profit expectations.
It has already been written that on the stock market, if history teaches that benchmark indices generally bottom out six months before the end of the recession, a rebound could set in shortly before the summer. Investors will, however, have to juggle downside pressures on corporate profits and a downward adjustment in price/earnings ratios driven by rising interest rates and heightened risk aversion. The whole being to put in a context where the analysts expect to see the companies to prioritize the refunding of a debt become expensive rather than to direct their liquidities towards the repurchases of actions and the increase in the dividends.
Human resources firm Mercer adds to the equation that a severe recession scenario is not yet captured by the markets, leaving room for a bearish or volatile market as the horizon clears. and that the full impact of the monetary tightening expected this year materializes.
That said, the theme of a slight recession lasting two to three quarters remains dominant in the discourse of analysts and economists, a thesis supported by the strength of the labor market. At Mercer, we made a comparison with past recessions, to see in the expected economic contraction resemblances to the recessions of the 1970s and 1980s, characterized by high inflation exacerbated by a geopolitical shock and a muscular monetary response despite a weakening of economic activity.
The current situation also has similarities with the exogenous shocks experienced during COVID-19 in 2020 and the terrorist attack of September 11, 2001, and with the Gulf wars (1990-1991) and Korea (1953-1954) . These recessions were less severe and short-lived, Mercer notes.
As for the impact on portfolios, people who stay fully invested when the storm hits the markets have tended to outperform those who exited the market and then looked for an entry point. Play the timing is always a big challenge.
From recession to recession, the basic rule remains the same: stay invested with a diversified portfolio, orient it towards growth over a long-term horizon while mitigating the impact of the problems of the recession, and maintain the flexibility to resort to tactical repositioning strategies favoring investments whose valuation has become attractive according to fundamental parameters.
This applies to equities, but also to the public credit securities market. Mercer points out that in a recession, the credit spread widens at the rate of the increase in the credit risk premium and expectations of default. In times of recovery, this gap narrows, and the performance of the credit market becomes positive, amplified by the rise in bond prices accompanying a decline in interest rates. “The temporary rise in the credit spread becomes a buy-hold opportunity for the investor and to ‘freeze’ an attractive spread for the long term. »
“Private placements (in equities and debt securities) can also become investment opportunities during the years following the recession,” notes the firm. And what about dividend shares, which deserve a new look.
Approaching retirement
In another study, Mercer gives a little wink to the investor approaching retirement and shaken by the underperformance of the financial markets last year, aggravated by inflation and the rise in the cost of living. A baby boomer turning 65 today would have experienced very poor stock market performance in 2022, with a typical balanced portfolio posting an average return of -10% or less over the year, depending on the composition of the stock market. the asset specific to this portfolio. “An investor, seeing such poor performance, may be tempted to swap stocks for low-risk assets, such as guaranteed investment certificates. But by eliminating the potential for asset growth with a properly diversified portfolio, that investor would be much more likely to run out of money before the end of their life—or potentially work extra years to prepare for retirement. Especially since a decline in interest rates is on the horizon for 2024. Transferring a portfolio to a guaranteed interest-based investment for only the first three years after retirement increases the probability of retirement by 10%. a retiree is short of money.
And delaying the start of government benefits like the Quebec Pension Plan and Old Age Security until age 70 instead of age 65 reduces the likelihood that a retiree will be cash-strapped in retirement by almost 15%, adds he.