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Sep 04

How to avoid the temptation to panic sell your portfolio during a recession

Reading Time: 5 mins

Falling share prices, a stuttering bond market, rampant inflation, and a predicted recession. Times are very tough for the UK economy right now.

Sadly, many believe that light at the end of the tunnel is a long, long way off, especially with energy prices set to hit eye-watering levels over the coming months.

So, given the current climate, is it safe to assume that the stock market will continue on its downward trajectory? And, if so, if it time to offload your portfolio before prices fall further?

In this article, we explain the in and outs of panic selling, and explain why you shouldn’t automatically sell shares just because the market has taken a tumble. Keep on reading for all the details or click on a link to head straight to a section…

 

what is a recession?

A recession is generally defined as two successive quarters of falling growth, as measured by Gross Domestic Product (GDP).

Last month, Bank of England revealed the UK will fall into recession this year. The announcement was unusual because the bank rarely makes predictions about the health of the economy.

That being said, the revelation would have come as no surprise to the many already feeling the impact of Britain’s struggling economy. According to the latest Consumer Price Index, UK inflation now stands at 10.1% – a 40-year high. Worryingly, many fear inflation will continue rising, possibly peaking at 18% by April 2023.

It’s important to note that a recession can be a normal part of an economic cycle. However, should employment also start to decline, then a prolonged period of ‘stagflation’ becomes a real possibility. This is where high unemployment and sluggish economic growth is coupled with rising prices.

 

how has the stock market performed in 2022?

2022 has been a year to forget for the UK’s biggest share indexes. At the time of writing, the FTSE 100 has fallen 1.28% since the beginning of January, while the FTSE 250 is down a colossal 19% over the same period.

The bond market has suffered this year too. Last week, UK 2-year gilt yields reached their highest since 2008, partly thanks to rising interest rates. Even if you aren’t directly invested in bonds, it’s possible you’re still affected by falling bond prices. That’s because pension funds often invest in bonds due to their perceived ‘low risk’ nature.

Yet it isn’t just UK stocks, shares and bonds that have suffered so far this year. Since 2022 began Japan’s Nikkei 225 index has fallen roughly 3%. Meanwhile, the German DAX has suffered a 18% fall, while the American S&P 500 is down a painful 16%.

 

will the stock market continue falling?

With stocks, shares, and bond prices all tumbling, it can be tempting to believe prices will continue on a downward slope. After all, the outlook for the UK economy looks rather bleak right now, and it’s unlikely things will rebound any time soon.

For example, we know inflation is set to continue rising. This will place additional pressure on the Bank of England to hike borrowing costs.

Higher interest rates can often correlate with a rise in unemployment, as it’s often suggested that higher borrowing costs make businesses relevant to invest, or take on new employees. Meanwhile, energy costs are set to reach stratospheric levels in a month’s time, which will heavily impact the disposable incomes of millions of Brits.

So, amid the current environment, it can be easy to form the opinion that stocks and shares will continue to perform poorly for the rest of 2022. However, while stocks and shares may indeed continue to fall over the coming months, there are no guarantees. That’s because past performance is never a reliable indicator of future performance. This goes for any type of investing.

To put it another way, just because the stock market has fallen in the past, it doesn’t mean this will continue in future. Likewise, if the stock market enjoys a sustained bull run, there are no guarantees the market won’t have a sudden change of direction.

beware of ‘hindsight bias’

When it comes to investing, it can be easy to fall into the trap of ‘hindsight bias.’ This is a phenomenon where investors look back at the past performance of stock and convince themselves that any rise or fall was easy to predict. In reality, this is rarely the case. Think about it – if predicting stocks and shares was that easy, then we’d all be millionaires!

In fact, hindsight bias can very dangerous, especially if it influences your future investing decisions and you then go on to suffer heavy losses.

‘the market’ is already one step ahead

While you may believe a recession will impact the prices of stocks and shares, it’s really important to understand that ‘the market’ has already considered this.

This doesn’t mean that shares won’t tumble if the UK economy suffers a fall in GDP over two successive quarters. However, it does mean that the market is already aware of the risk of a recession. In other words, the current value of the stock market will have already ‘priced in’ the chances of an economic slump.

It is for this reason why unexpected data often has the biggest, immediate impact on stock prices, as opposed to data that simply confirms what was already anticipated. For example, right now, the chance of a future recession is very likely. This is why it’s possible stock prices will barely move if, and when, the country officially enters a recession.

The market already being ‘one step ahead’ can also explain why markets are typically more volatile during times of economic uncertainty.

 

Avoid the risk of ‘panic selling’

Are you considering selling investments because you fear for the state of the UK economy? If so, it’s possible you’re investing outside of your personal appetite for risk.

Holding an investing portfolio sitting outside of your tolerance for risk can be dangerous. This is because it can lead to ‘panic selling’. This is where you ‘panic’ to sell stocks before they fall further. Ironically, if lots of investors panic sell, this can increase the risk of a market crash. This is because prices can plummet when lots of investors seek to offload the same stock all at once.

Panic selling is also one of the easiest ways of crystallising losses during the first signs of a downturn. In simple terms, it’s a bad investing strategy. Instead, committing to a long-term investing mindset and regularly re-balancing your portfolio can all help in a struggling market.

To limit the risk of selling your stocks in fear, take a look at our article that explains how to set your investing strategy. If you’re completely new to investing, also take a look at our article that outlines how to start investing.

 

Disclaimer: MoneyMagpie is not a licensed financial advisor and therefore information found here including opinions, commentary, suggestions or strategies are for informational, entertainment or educational purposes only. This should not be considered as financial advice. Anyone thinking of investing should conduct their own due diligence. 

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