Customers helped

Investors take steps to protect against a downturn

Updated 20 December 2022

4min read

Nick Green
Financial Journalist

Fears of a global downturn and other pressures such as Brexit are prompting UK investors to take a defensive stance. Higher-growth equities are being ditched in favour of more stable bonds and gold, which are seeing extraordinary demand. Article by Nick Green.

Investing in a downturn

The US-China ‘trade war’, economic slowdown in Germany and worries about a no-deal Brexit have given the world economy at least three reasons to be jittery. Following an unusually long period of growth in both the US and Europe, geopolitical events and weak economic data are combining with a number of familiar warning signs to put investors on the alert.

Since the 1950s, one of the most reliable bellwethers of an imminent US recession has been bond yields. Bonds are generally seen as a secure bunker in which to ride out an economic downturn, since they provide a fixed-income investment over the medium to long term. Recently, US Treasury bonds underwent a ‘yield curve inversion’ – meaning that 10-year bonds started to offer a lower payout rate than two-year bonds, when the opposite is normally the case. In the past, this phenomenon has consistently been seen shortly before a recession. It happens because investors become willing to sacrifice yield levels for long-term security – in other words, they fear the market is heading downwards.

Bonds have become so sought-after that some are now offering negative rates, meaning that lenders are effectively paying borrowers for the privilege of lending to them. The lenders only benefit long-term because they stand to lose less than they would if invested in stocks & shares or cash.

The UK’s two and 10-year gilts also showed the same yield curve inversion, though this is less commonly seen as a recession indicator.

Negative interest rates result in lenders paying borrowers

Negative rates are increasingly being seen in the mortgage markets of some countries. The Jyske Bank in Denmark has issued a 10-year mortgage with a rate of minus 0.5 per cent, so that the borrower’s overall repayment will be less than the amount they borrowed (though they still have to pay mortgage fees).

While this sort of thing may be great for borrowers, it’s much less welcome for those holding assets in cash. Some European banks are already effectively charging their wealthier customers ‘room and board’ to keep their money there, by paying negative interest. When combined with the effects of inflation, this results in cash being less ‘safe’ than its reputation suggests. Even in these banks, however, negative interest rates are only being applied to accounts with balances of several hundred thousand euros or more, so ordinary savers do not yet have to worry about this. However, interest rates may still be so low that the value of their savings decreases with inflation.

Investors rush towards gold

Another sign of growing financial anxiety is the price of gold. Gold recently hit a six-year high of over £1,260 an ounce, having soared from just £983 an ounce at the start of 2019 (a 28 per cent rise). The UK fund supermarket Interactive Investor reports that gold trading tripled from July to August, fuelling the latest steep rise.

Like bonds, gold is also seen as a go-to ‘haven’ investment in times of financial gloom, as it tends to rise in price when equities fall (precisely for this reason). It is also usually far less volatile than equities, which is why its meteoric rise in 2019 has raised eyebrows.

How to invest to protect against a recession

The past few years have seen relative stability and strong growth, which has encouraged investors to take more risks. Many portfolios designed in this environment may have to be reconsidered and/or restructured, to cope with greater uncertainty.

‘You need to budget for the fact that after a 10-year period of bumper returns, things are going to get a little harder from here,’ says Russ Mould, investment director at AJ Bell. Preventative measures are typically more useful than reactive ones. For example, if an investor waits for a downturn to begin before shifting into lower-risk assets, then all they will do is crystallise (i.e. make real) the losses on their investments. The challenge for investors is therefore to time any such move to happen just before any dip – though of course such dips are notoriously hard to predict with accuracy.

Tom Stevenson, investment director at Fidelity International, says diversification is the key. ‘Because we do not have a crystal ball, we can only seek to minimise the ups and downs of our investments by putting our eggs in a variety of baskets.’ Multi-asset funds spread the risk by investing in a range of asset classes, sectors and regions. Another way to prepare for troubled times is to shift more assets into cash while the market is buoyant, so that the cash is ready to deploy in buying up more stable investments.

A further option is to select defensive stocks. An investor may be able to identify which equities prove most resilient in a declining market, and cherry-pick these stocks to create a portfolio with more 'recession resistance'.

As already mentioned, gold tends to rise significantly in value during uncertain times. That said, it remains to be seen how long its current growth spurt can continue. The gold price is already not far off its record high (in 2011 it recorded a price of $1,917 an ounce – it is now $1,529).

The most important rule for investors facing a period of negative growth is not to panic. Those with long-term investments in place would usually be advised to sit tight and ride out the storm. However, individuals with imminent investment goals who hope to crystallise their gains in the near future, should consult their financial adviser about possibly rebalancing their portfolio.

Match meI’d like to speak to a financial adviser

About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.