Recessions can be tricky to predict, and even trickier to navigate. Investments you might traditionally think of as safe might in fact expose you to more risk depending on the economic environment.
Your first instinct might be to let go of all your stocks and move into bonds, but high-yield bonds can be particularly risky during a recession.
High-yield bonds, with credit ratings below investment grade, are riskier than government debt securities, and are highly susceptible to market downturns. The issuing companies are often smaller, indebted and of overall lower quality, and in times of market uncertainty can be more likely to run into trouble.
Stocks of highly-leveraged companies
Companies carrying high levels of debt on their balance sheets should be avoided during a recession. The price of a highly indebted company is more likely to fall during a recession. If a company struggles to pay back its debts due to decreased demand and an overall economic slowdown, its stock price can fall quickly and the company may even fall into bankruptcy.
Although indebted companies can tumble in a recession and present investment opportunities later on, a defensive investor should stay away while the company faces clear business challenges that must be overcome.
Consumer discretionary companies
Consumer discretionary stocks are popular during boom times, but their goods and services fall outside of everyday essentials like utilities and healthcare. Well-known consumer discretionary companies include Tesla and travel companies such as cruise lines or airlines.
This sector can be particularly susceptible to recessionary pressures, as the economy slows and people start spending less. Consumer discretionary companies move more dramatically with consumer sentiment and economic cycles, which can worsen in times of financial uncertainty.
Other speculative assets
Speculative assets are high-risk, high-reward investments such as penny stocks or stocks of companies with little to no earnings. Penny stocks are small companies whose stocks trade for very low prices. They’re not typically listed on major exchanges, and often do not provide financial information, giving investors little transparency and making them risky investments.
In recent years, many companies have used cheap debt to finance their operations, hoping to show revenue growth and worry about earnings later. But as the economy slows, revenue growth is harder to come by and with higher interest rates, investors want to see more in the way of earnings today. These companies can be hit by both a business downturn and a reduced valuation because of higher rates.
Many consider cryptocurrencies like Bitcoin to also be speculative. Cryptocurrencies don’t have intrinsic value because they don’t generate anything for their owners, such as dividends or earnings. Cryptocurrencies experience volatile price swings, and may see significant losses during a recession.