Recession: How investors should respond and prepare during an economic downturn

Why Should You Pay Attention to Recession?

As an investor, you may hear analysts discuss economic growth data every year, but the true test of your portfolio’s resilience often isn’t during periods of prosperity, but when an economic downturn occurs. Recession not only affects your return expectations but also determines whether you can survive market volatility and seize opportunities.

What Exactly Is a Recession?

A recession is a period characterized by a significant slowdown in economic activity across a broad range of sectors, lasting for a certain period. Economists typically define it as two consecutive quarters or more of economic contraction. However, if a recession lasts longer than 3 years and GDP declines by more than 10%, it can evolve into a more severe Depression.

Historically, the United States has experienced only one major depression—the Great Depression—that began in 1929 and lasted through the World War II era, over 10 years, leading to massive unemployment, a sharp decline in production, and a collapse in investments.

Since independence, the U.S. has gone through over 48 recessions. The start and end points of each recession are announced by non-profit research institutions like the National Bureau of Economic Research (NBER). NBER defines a recession as “a significant decline in economic activity spread across the economy, lasting at least two quarters or six months, measurable by indicators such as GDP, income, employment, industrial production, and retail sales.”

What Causes Recession?

The causes of recessions are diverse and complex. Historical records show several main triggers:

Cost Shocks and Inflationary Pressures
The oil crises of the 1950s and 1970s sharply increased production costs, leading to rising prices and severe inflation. This was followed by a rapid contraction in purchasing power—the core driver of economic growth was cut off.

Government Tightening Policies
To curb inflation, governments sometimes implement overly aggressive tightening measures. Consumer spending is forced to decline, and if the reduction is too large, it can trigger a recession.

Asset Bubbles and Credit Crises
Before the 2007 financial crisis, asset prices soared, and credit expanded rapidly. Massive debts accumulated to unsustainable levels for corporations and households. When the debt chain broke, investments and consumption collapsed simultaneously, dragging down the entire economy.

Decline in External Demand
Economies heavily reliant on exports are particularly vulnerable. When major trading partners (such as the U.S., China, Germany, Japan) slow down, the entire global supply chain is affected.

Black Swan Events
Unexpected events (like pandemics, geopolitical shocks) can destroy demand and supply sides in a short period.

Economists typically monitor leading indicators such as credit expansion, rising asset prices, and increasing unemployment to warn of recession risks.

The Three Recessions the U.S. Has Experienced in the Past 20 Years

First: Dot-com Bubble Burst (March 2001 - November 2001)

• Duration: 8 months
• GDP contraction: -0.3%
• Peak Unemployment Rate: 6.3%
• Causes: Excessive speculation in tech stocks, with the Nasdaq plunging 82% from 4861 to 850. Coupled with the 9/11 terrorist attacks, the Federal Reserve was forced to cut interest rates from 6.5% in July 2000 to around 1% by mid-2003.
• Features: Limited recession impact, relatively short duration.

Second: Great Recession (December 2007 - June 2009)

• Duration: 18 months
• GDP contraction: -5.1%
• Peak Unemployment Rate: 10.0%
• Causes: Housing bubble and financial derivatives risk. Home prices soared from an index of 140 in 2000 to 220 in 2006-2007. Financial institutions created complex financial products (mortgage-backed securities) with insufficient risk dispersion. Falling home prices triggered a chain reaction, spreading the financial crisis to the real economy, resulting in a 5.1% GDP decline and massive unemployment (unemployment hit 5.5% at the end of 2008).
• Response: The Fed launched quantitative easing (QE), injecting $1.75 trillion; cut interest rates near zero; additional QE in 2010 and 2012. The crisis also affected the Eurozone.

Third: COVID-19 Pandemic Shock (February 2020 - April 2020)

• Duration: 2 months
• GDP contraction: -19.2% (most severe)
• Peak Unemployment Rate: 14.7%
• Causes: The pandemic emerged in late February 2020, spreading to the U.S. in March. Travel restrictions and shutdowns caused demand and supply to collapse simultaneously. Unemployment surged from 3.5% in February to 14.7% at year-end. Asset prices fluctuated wildly.
• Response: The Fed launched QE4, expanding its balance sheet from $4.1 trillion to nearly $9 trillion; policy rates remained near 0.25% until March 2022.

How Do Asset Prices Fluctuate During a Recession?

Recessions typically trigger Risk-off sentiment. Investors tend to sell high-risk assets (stocks, commodities) and move into safe-haven assets (gold, bonds, strong currencies).

For example, during the COVID-19 pandemic, in just over a month:

• Dow Jones Index: dropped from 29,568.57 to 18,213.65, a decline of 38.40%
• Crude Oil: nearly fell from $54/barrel to below $1, a drop of nearly 98%
• Gold: rose from $1,567/oz to $2,067/oz, up 32%
• 10-year U.S. Treasury Yield: fell from 1.672% to 0.322% (price increased by 80% as investors flocked to buy)

However, the performance of safe-haven assets is not always consistent. When the government initiates QE, the dollar, although a safe asset, can depreciate due to increased supply, with a 13.5% decline in 2020. This reminds investors that relying solely on one asset class carries risks.

What Should and Should Not Investors Do?

❌ Recession Investment Taboo

Increase risk asset positions
High-risk assets tend to suffer significant losses during recessions. Increasing exposure is akin to pouring gasoline on a fire.

Over-leverage
While recessions can be opportunities to buy quality assets at lower prices, high debt levels weaken your purchasing power and long-term investment capacity. Be especially cautious about borrowing during a recession.

Choose floating-rate loans (ARM)
In early recession, interest rates may fall, but they tend to rebound during recovery. Opting for floating-rate loans could lead to higher repayment burdens later.

✅ Recommended Actions

Allocate to safe-haven assets
While safe assets do not guarantee the best returns at all times, they can protect principal during early recession stages and prepare for subsequent opportunities.

Maintain stable income sources
Steady employment income is the foundation for continued investing during a recession. Use asset price dips to gradually build positions.

Choose fixed-rate loans (FRM)
Lock in long-term low interest rates during a recession with low rates, such as for home mortgages, which is a wise move.

Final Thoughts

Economic growth periods are widely discussed, but Recession is the true test of your investment portfolio’s resilience. Savvy investors cannot predict recessions with certainty, but they can prepare in advance. Through proper asset allocation and diversification across different asset types, your portfolio can survive and thrive in any market environment.

For well-prepared investors, a recession is not a disaster but a golden opportunity to accumulate quality assets at lower costs.