As we reach the end of this year, there are widespread discussions about a possible upcoming recession. In fact, the US economy slowed down by 0.6% in Q2, and 1.6% in Q1, prompting some to argue that the country is already in a recession. Recession fears are even more prevalent in the Eurozone, despite having grown by 0.8% and 0.7% in Q2 and Q1 respectively, as looming gas supply shortages threaten economic stability. Whilst it’s important to note that none of the two economies are officially in a recession, it is equally important to understand under which circumstances a possible recession would materialise, how it would look like and what it would actually mean for your pension savings.
What is a recession?
A recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.” A slowdown in growth can spill over across an economy through various channels, via deteriorating company sales, higher unemployment, lower consumer demand, credit events and bankruptcies, factors that also need to be considered when assessing whether a country is in a recession. The order by which the above events unfold may vary. Currently both the US and Eurozone enjoy multi-year low unemployment rates, U.S. manufacturing sector continues to expand and wages have grown.
So why do Markets expect a recession?
Prices jumped in 2022 as a result of 1) increased post- Covid consumer demand, 2) supply chain disruption, caused by prolonged China lock-downs and 3) the ongoing war in Ukraine that has driven food and energy prices up. Faced with record high inflation, central banks increased interest rates to encourage people to save more money and spend less in order to decrease the demand side pressure on inflation. Unfortunately, inflation has proven persistent and central banks appear determined to keep raising interest rates aggressively until inflation drops at acceptable levels. However, prolonged higher interest rates increase companies’ costs that in turn could start laying off people, significantly hurting consumer demand and eventually driving the economy in a recession.
How does this reflect in your pension savings?
During recessions, companies’ profits along with their prices may take a hit resulting in an overall stock market drop. If you are invested in a pension fund that is largely made up of equity holdings, this could translate in a deterioration on the value of your savings. However, equity prices are not necessarily driven by actual economic conditions present at the time. Drops in the equity markets usually reflect investors’ expectations of a deterioration in companies’ future earnings, even though that may not have happened yet. Equity markets may suffer loses before the actual economy. Over the last 69 years, on average, equities performed worse in the year preceding a recession than during the recession, while the S&P 500 rose on average by 1% during all recession periods since 1945 (Forbes, 2022).
If we are indeed heading into a recession, it is possible that your portfolio has already taken a significant part of the hit. Also don’t forget that your new contributions every month are now buying pension fund units at lower prices lowering your average cost value and enhancing your profits when the markets eventually recover. Lastly, no one can predict with certainty how markets will move. So, it is essential to remain invested with a strategy that matches your investment horizon, your investment objectives and your appetite and tolerance to risk. As always, the Ancoria team is here to help you so don’t hesitate to contact us if you would like to discuss about your pension account.