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What Is Recession And Why Should It Matter To You

“The Eurozone has been confirmed as entering a ‘technical recession’ after the region shrank by 0.1% in Q1 2023, marking two consecutive quarters of contracting GDP.” (Source: Economic Times)

Historically, we know that a recession spreads like wildfire across geographies because of the intertwined nature of global economies. The last time the global economy showed signs of recession was back in 2008; a recession that India largely avoided to be affected by due to the strong presence of public sector banking. But, what does the oncoming recession mean for India – and by extension for young investors in India?

Let’s find out!

What is Recession?

Imagine the economy as a giant wheel that keeps turning. Sometimes, this wheel spins really fast, and other times, it slows down. What happens in each of these scenarios?

Everyone gets stuck – they are making no progress at all in the slow times, much like a slow climb up a steep hill! There might be a need for emergency rescuers, and there is a sense of urgency and panic in the whole situation. So, when this metaphorical economy wheel slows down, it has repercussions in the real world. People have to slow down and be more careful with their finances and spending because they don’t know for sure how long they will be stuck here! The job market starts to look bleak; some people might even lose their jobs – and there is a sense of urgency and panic in the whole situation – which is best described as a recession.

This is a roundabout (See what we did there… The wheel thi… Never mind.) way of saying that a recession is that phase when the economy of a country is not doing too well. Businesses, financial institutions, investments, and investors in a country are all affected by a recession.

Recession

How does the recession affect the economy?

Let’s first look at the various effects of recession on the economy – 

  • Unemployment – During a recession, companies might not make enough money, and to save money, they might stop hiring new employees or even lay off some of their current workers. This leads to more people being without jobs, which puts a lot of financial strain on the masses of the country.

     

  • Consumer Spending – No jobs = No spending! When people worry about the future during a recession, they tend to spend less money on non-essential things. It becomes important to prioritize your expenses at such a time. This can make companies earn even less, and it becomes a cycle – if companies aren’t making money, they can’t hire more people, and if people aren’t working, they can’t spend money. In fact, one of the key reasons for the current recession in Europe is that an inflation in energy prices led to lower consumer spending, leading to the troubling times that the continent is experiencing today.

     

  • Stock Market – The stock market is a reflection of how companies are doing in a recession. See point 2☝️- that’s how they’re doing. A recession can cause the stock market – that place where people invest in companies! – to go down. When companies are making less money, their stock prices can fall, which means that if you own a part of a company’s stock, its value might decrease.

     

  • Housing Market – Now, with people out of jobs, and job-givers out of money, you can be sure that no heavy spending is taking place. Because there is a natural decline in the demand for housing, the value of houses can also drop during a recession. This can be a tedious problem for people who own homes because if they want to sell, they might not get as much money for their house as they hoped, and might not even break even in some cases.

     

  • Government Revenue – With businesses and individuals earning less money during a recession, they pay proportionately less in taxes. This can make it harder for the government to fund important services like schools, hospitals, and infrastructure projects – the lack of all of which is a hindrance to a country’s growth.

     

  • Global Impact – In today’s interconnected world, a recession in one country can affect others. If a big country’s economy slows down, it might buy fewer things from other countries, impacting those economies as well. And um, in case you were wondering… Just to give you an idea of what happens if India goes into recession – India is the fifth largest contributor to the global GDP as of 2022 – you do the math!

These are the major ways in which a country’s economy is affected by a recession. If you’re a keen observer, you will notice just how interlinked these six factors are. The recession sets off a bit of a domino effect that can potentially tumble the whole economy.

How does the recession affect the investor?

Recession For the Investor: In a Nutshell

We want to touch upon 4 key ways in which the recession of a country will have a direct impact on you – the investor in its market – 

  • Job Market Destabilizes – For a young individual just starting in their career, a recession can make it harder to find a job. Companies might not be hiring as much, which means there’s fierce competition for available positions. In extreme situations, companies might also generally be laying off employees, creating a serious deficit of income.

     

  • Stock Market Becomes Volatile – If you’re investing in the stock market, a recession can be tricky. Stock prices might drop, which can be scary if you see the value of your investments going down. But remember, the stock market usually recovers over time – so in a typical recession – it is prudent to stay invested. Long-term investments should generally be able to recover losses over… erm… well a longer term.

     

  • Opportunists Paradise – Some investors would view a recession of the stock market as an opportunity to buy more at low prices. But, beware – you cannot make investments at such a time without having serious experience or guidance about knowing where to invest. Yes, things might seem like they’re on sale, but the real question to consider is – which ones will be doing well when the market does start soaring again?

     

  • You’ll be Thankful for Diversification – Yes. You can in fact feel gratitude even in the midst of a recession – if you have preemptively mitigated risk! A recession will reiterate the importance of having a diversified financial portfolio. If all your money is in one type of investment and that area gets hit hard, you could lose a lot. But if you’ve spread your investments across stocks, bonds, real estate, funds, etc., it can help reduce the impact of a downturn significantly.

Recession sounds scary, and it probably is a little – but like we said – the economy is a wheel! Whatever is going down is coming back up – as long as you’re in the know and have contingency plans in place for your investments, you’re poised to survive!

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