What Is a Recession, and Is the UK in One?

With all the chaos of high inflation and interest rates, a new cost-of-living crisis has emerged in the UK. And there are now looming fears that an economic recession could be just around the corner. 

But what exactly is a recession? And what are the tactics available for investors to protect their portfolios? Let’s dig in.

What is a recession?

A recession is a prolonged period of widespread economic decline that entails a rise in unemployment, a fall in the stock market, and a drop in the housing market. 

They occur similarly to a domino effect, where one or more factors trigger a chain of events leading to widespread decline.

For example, as economic conditions begin to wobble, businesses start to cut back on spending to preserve their financial health. This usually entails layoffs, which leads to rising unemployment. 

With households earning less money, consumer spending starts to suffer, leading to growth grinding to a halt. As growth evaporates, demand for expensive assets like homes starts to fall, resulting in lower property values. Meanwhile, it also causes stock valuations to suffer as earnings targets are missed and dividends cut.

What does a recession mean?

The impact of a recession on households is significant. Even those who are fortunate enough to remain employed are still affected.

The drop in property values can indirectly impact overall wealth. Meanwhile, poor performance in the stock market and bond market can adversely affect retirement savings and pension investments, potentially compromising retirement plans.

But beyond monetary damage, research has shown recessions cause psychological impacts. A 2016 study published by BMC Public Health identified a strong correlation between recessionary effects and mental health. Specifically, the investigation found that unemployment, income decline, and unmanageable debt often lead to a spike in depression, substance abuse, and in some cases, suicide.¹

Is the UK in a recession now?

Despite what many fear-inducing headlines suggest, the UK is currently not in a recession.

A reduction in gross domestic product (GDP) is often used as an early indicator of a recession. And between July and September 2022, GDP shrank by 0.2%, ending the country’s economic growth streak since the Covid-19 downturn in 2020. Therefore, there is valid concern among financial experts that a recession is on the way.

However, recessions are typically defined as two consecutive quarters of GDP contraction. In other words, the UK is currently only halfway to fulfilling the requirements. Should the fourth quarter of 2022 show another drop in GDP, the UK likely will fall into a recession. Alternatively, these fears may be shelved if the economy returns to growth.

Investors will have to wait until early 2023 for the economic figures to be available.

How long do recessions last?

The longest recession in British history was the Great Slump in 1430, which lasted approximately 60 years. However, since the end of World War 2, recessions, while still devastating, have gotten much shorter.

For example, the British recession following the 2008 financial crisis only lasted five quarters, ending in 2009. And that was after a near-complete collapse of the global banking system. On the opposite end of the spectrum is the Covid-19 recession in 2020, which lasted a grand total of two months.

Each recession has a different length. But on average, they typically last for approximately 10 months.

According to the British Chamber of Commerce, the UK’s economy is expected to enter into a recession that will last five quarters ending at the start of 2024.² However, forecasts can be inaccurate. If the UK does indeed enter a recession, it could be much shorter or longer than expected.

When was the last recession? 

The 2020 Covid-19 global pandemic triggered the most recent recession in the UK. The rapid closure of businesses and borders during lockdowns created an economic shock that hurt almost every sector of the economy – and many have yet to recover.

However, it only took roughly two months for GDP growth to resume, making it one of the shortest recessions in history. Nevertheless, it marked the end of nearly 16 years of consecutive economic growth in the UK and one of the longest bull markets on record.

What causes a recession?

Despite numerous recessions occurring throughout history, both in the UK and abroad, each has been quite different. Yet, there are two primary factors that many previous recessions have had in common:

• High interest rates: As interest rates rise, the cost of external capital increases, making it more expensive for businesses to raise money. This can lead to projects remaining unfunded. But for companies dependent on external financing to keep the lights on, it can lead to layoffs as they prioritise preserving financial resources. To make matters worse, consumer debt such as credit cards, buy-now-pay-later, and mortgages also become far more expensive to service.
• Falling consumer spending: As consumer confidence and household incomes suffer, spending on discretionary items can sharply decline as families seek to save money. This results in tightened cash flows for businesses, which can lead to further layoffs, creating a loop of economic calamity, eventually triggering a recession.

How to ride out a recession

Needless to say, a recession is bad news for both consumers and investors. But there are several recession investment options to help prepare for and ride out the storm.

1. Build an emergency fund

Regardless of the potential severity of a looming recession, having an emergency fund is prudent short-term financial planning. By having sufficient cash saved up to last around six months, households can avoid dipping into investments or, worse, taking on expensive debt to cover their monthly bills should unemployment come knocking at the door.

While still stressful, having sufficient savings provides ample financial flexibility when searching for a new job.

2. Cut unnecessary spending

Reducing small luxury expenses can quickly add up to considerable savings. Cancelling barely used subscriptions or skipping the morning coffee can help lower costs, making income and savings go further.

3. Pay down debts

In a recessionary environment, interest rates are often on the rise. And that can significantly increase the cost of having any personal debt. Mortgages can’t typically be paid off quickly. But wiping out outstanding balances on credit cards or buy-now-pay-later schemes is vital to reduce the risk of having an out-of-control interest bill at the end of each month.

It’s generally recommended by financial planners to first pay off the debts that incur the highest level of interest and work down the list to the debts with lower interest rates.

4. Diversify investment portfolios

Each stock market sector is impacted differently during a recession. And some recover significantly faster than others. By having a diversified investment portfolio, investors avoid being overly concentrated in a sector that may lag.

This improves protection against falling share prices and potential dividend cuts.

5. Keep investing

Providing that there isn’t a more immediate need for capital, investing in the stock market during a recession can be a lucrative decision in the long term. 

Recessions often lead to panic within the stock market, resulting in many top-notch enterprises watching their stock prices fall below intrinsic value. This creates bargain buying opportunities for patient investors. And buying and holding businesses that can thrive in both the short and long term can create considerable wealth when investor confidence returns and the stock market recovery begins.