The UK officially entered a recession on Thursday (15 February) after two quarters of economic contraction in the second half of 2023.
GDP slipped back 0.3% in the three months from October to December having fallen 0.1% in the previous quarter. While shallow, the technical recession means the UK economy is in reverse.
It comes as high interest rates have squeezed consumers and businesses. While inflation has fallen from the record highs seen in late-2022, it remains at 4% - double the rate the Bank of England needs it to be.
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So, now it's been confirmed that the UK is in a recession, how should you approach investing?
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1. Diversify your portfolio
Diversification is of course important, but a well diversified portfolio could serve you well during a recession.
Laith Khalaf, head of investment analysis at AJ Bell, said: “Economic hardship puts pressure on businesses all across the market spectrum and you never know precisely where the cracks are going to appear, so you shouldn’t have too much in any one stock, fund, industry or region.”
Make sure you also keep the number of investments in your portfolio manageable – if you have too many, you may find it difficult to manage and act on time sensitive news like profit warnings, for example.
2. Don’t over-trade
Although you should regularly review your holdings, it is important you don’t over-trade, which could lead to costly mistakes.
“When markets are volatile and losses are mounting, you might be drawn into doing something just to try and exert some sort of control. It’s incredibly tempting to be a portfolio vigilante and take matters into your own hands, distributing some natural justice by petulantly dispensing with investments that have fallen in value. But you should resist that temptation and only make changes based on reasoned considerations rather than on a gut reaction,” says Khalaf.
3. Make the most of your Isa and pension
Make the most of your Isa and Sipp allowances to ensure you are investing in a tax efficient way.
“The annual benefits that are yielded by these simple steps might seem small, but they will compound your returns year in year out, and lead to a bigger nest egg when you come to draw on it. This is especially important given the raft of tax rises we are seeing on earned income, capital gains and dividends over the next few years,” he adds.
4. Don’t ignore dividends yields
Khalaf adds that you should also pay close attention to dividends. “When growth is thin on the ground, dividends can keep your investment scoreboard ticking over. Poor economic conditions aren’t great for profits and hence dividends, but many companies used the shock of the pandemic to cut their regular shareholder payouts and reset them to much more affordable levels.”
Dividend cover for the FTSE 100 currently sits at 2.16, according to the AJ Bell Dividend Dashboard.
“That means company profits are more than double the amount of dividends being distributed, giving companies a large buffer before they need to start thinking about cutting back again.”
5. Think ahead
“It’s extremely important to recognise that an expectation of future economic conditions is already baked into share prices. Companies which are heavily exposed to under-pressure consumers, such as retailers and travel stocks, have already seen sharp falls this year, while defensive stocks like tobacco companies have had a much better ride,” Khalaf adds.
“The market is always looking ahead and though it might sound strange, now is probably a good time for investors to be anticipating better economic climes, rather than fretting about the current malaise.”
Indeed, the Bank of England, OECD and IMF all expect the UK to grow over the course of 2024 and 2025.
Times of downturn can pave the way for opportunities that may not have been accessible during a bull market, says Bill Nixon of Maven Capital Partners.
“The best value is often available when confidence is low or capital is in short supply,” says Nixon. “Instead, when buyers of assets are exuberant and capital is plentiful, that naturally drives higher prices – until there is an equally natural correction.
“Even in a time of economic contraction, the core principles of investing remain the same. Of course, prices will vary depending on market forces and conditions, but quality will always have the upper hand.”
He suggests technology and cybersecurity, consumer staples and healthcare tend to do better in economic downturns while non-essential, cyclical areas may suffer such as tourism and retail.
“The same goes for highly-leveraged companies,” adds Nixon. “As well as already struggling to sustain their debt payments, these businesses might face a decrease in revenue, on top of a wide range of other challenges brought about by the recession."
Khalaf says it might be a good time to start thinking about drip feeding money into the market, in recognition of the fact that the global market may yet have further to fall.
“The UK recession is expected to be shallow, so companies will be trading into an economy that is going down a slight slope rather than plunging off the edge of a cliff. That still gives good companies the ability to grow. Investors should also take note that their investments are likely only partly in thrall to the UK economy, with many funds and indeed companies on the London Stock Exchange deriving lots of their earnings from overseas. Economic growth in the US and the Euro area isn’t looking particularly rosy either, though they are forecast to do better than the UK next year, according to OECD projections.
It is important to remember that recessions happen and it is normal to have ups and downs, but regularly investing can help smooth out returns.
