Investing in dividend stocks during a recession can be a great way to earn passive income. And an economic downturn can be a great time to buy stocks to build wealth.
In the last century, there have been nine recessions in the UK – an average of one each decade. And another one looks like it might just be around the corner.
Economic forecasts
According to Gurpreet Gill, a macro strategist at Goldman Sachs, the UK is more likely to enter a recession than either Europe or the US. The causes of this are reasonably straightforward.
Right now, the Bank of England is struggling to bring inflation below 8%. And interest rates are now forecast to reach 6.25% next year before they come down.
Neither of these is good news for shareholders. Higher interest rates might create a headwind for sales, presenting an issue for growth investors.
Equally, income investors might find high inflation a problem. Increased costs are likely to weigh on margins, leaving less cash for companies to return to shareholders as dividends and buybacks.
There’s no two ways about it, this is not good for companies and it’s equally bad for investors. And while no business is entirely immune to these headwinds, some are more sheltered than others.
Risks and rewards
Some businesses are better-placed to handle recessions than others. Coming out of the Covid-19 recession, for example, easyJet suspended its dividend, while Halma boosted its returns by 4%.
Bill Nixon, managing partner at Maven Capital Partners, puts this down to two things. The first is some businesses having stronger balance sheets than others.
This is clearly relevant, but it doesn’t tell the whole story. The other reason Nixon identifies is some businesses are more closely tied to the macroeconomic environment than others.
According to Nixon, there are three main sectors where demand for goods and services tends to hold up well in a recession. These are technology, consumer staples, and healthcare.
For dividend investors, this means a steadier, more dependable stream of passive income. For growth investors, this means a relatively predictable path to increasing revenues and profits.
Investing in a recession
This gives investors plenty to think about in terms of finding stocks to buy. And the key to investing well in a recession is identifying areas where the market is more pessimistic than it ought to be.
This can involve companies that are exposed to the underlying economy, but not to the extent implied in their share price. I think Forterra and JP Morgan fall into this category.
There’s a risk a prolonged recession might weigh on earnings for some time. But I think the current share prices more than compensate for this in both cases.
Alternatively, companies that are relatively insulated from a downturn but whose share prices are falling could be great opportunities. Unilever and Kraft Heinz look good to me.
The main risk with both stocks is higher inflation weighing on margins. But the underlying companies have shown some ability to mitigate this with their scale and brand strength.
Opportunities
A recession itself isn’t a good thing for investors. But the pessimism that comes with it can be a source of unusually good opportunities.
For dividend investors, this can mean opportunities to buy shares with abnormally high yields. As the UK continues to battle macroeconomic headwinds, I think this is a great time to be an investor.
