The stock market typically enters a bear phase during a recession (when stocks are falling or are already at their lowest levels). Investors are often reluctant to reinvest in such a market, as the risks of falling share prices keep them further away. To complicate a gloomy situation, a recession has no expiration date: it can last a few months or drag on for years
Another way to view a bear market is to think of it as a sell-off, where stocks are available at deep discounts from their normal levels. However, as any experienced shopper knows, not everything on sale is a bargain. Investors should avoid being pressured into buying anything because it’s cheap. However, if investors choose the right strategy when selling, they can get great deals from a long-term investment perspective.
Generally, economic activity decreases during a recession. Companies are unable to increase their profits due to the slowdown in revenue. People prefer to save rather than spend, which in turn affects the company’s income. Firms then postpone or cancel capacity expansion or end up with excess capacity. This, in turn, freezes new hires or even leads to layoffs, making people feel weaker about spending. Governments generate relatively little tax revenue and are therefore able to reduce their spending on various projects. In general, the economy is entering a negative cycle of lower production and slow demand.
However, long-term investors would find that economies bounce back from recessions, as would stock markets. Usually, changes in the stock market lead to changes in the business cycle, which means that the stock market would fall first and then a recession or slowdown in the economy would occur. However, every drop in the stock markets is also an opportunity for investors to buy stocks cheaply, especially from a long-term perspective. Even if investors have the courage to invest, the key questions remain: when and how to invest (strategy). Can investors accurately set the price floor or time the market in a bear market? While it may be very appealing to try, investment professionals (including fund managers) strongly advise against making such a decision, as there is no formula that can accurately predict the right time to invest. Therefore, the focus should be on the investment strategy.
There are two main investment strategies that investors usually follow
Instead of trying to invest in individual stocks (even if they are available at bargain prices), this strategy allows investors to invest in mutual funds. When stock markets recover from a bear run, the rally is usually broad-based (several stocks rise together). Investing in a diversified mutual fund is better than investing in a few select stocks because investors stand to benefit from such a large rally. This strategy would outperform some of the best-performing stocks at the top of the performance chart. However, the risk is also less than investing in bad stocks that may not recover even if the rest of the market does.
This strategy is only suitable for investors with a working knowledge of how the stock market works and what causes price movements. It is also suitable for investors with a higher appetite for risk or the ability to absorb losses without financial difficulties. These investors are also aware that some sectors are more resilient than others in a bear market. For example, companies in sectors such as consumer goods, pharmaceuticals, and health care are more resilient due to the nature of the demand for those goods and services. Well-informed investors, therefore, avoid cyclical sectors such as real estate, where the turnaround time can be long and span several years.
More sophisticated investors who thoroughly research companies are better able to choose individual stocks to invest in. One of those filters for companies is a proven track record of recorded growth even during recessions.
In general, recessions offer opportunities for long-term investors to participate in the stock market at bargain prices. However, the time horizon for such investment should be long-term and investors should have a sound strategy that suits their investment style and knowledge of the stock market.