How to Navigate a Recession

Holly Black: Welcome to the Morningstar series, "Ask the Expert." I'm Holly Black. With me is Dan Kemp. He's chief investment officer at Morningstar Investment Management. Hello.

Dan Kemp: Hello, Holly.

Black: So, we're here today to look at what happens if we go into recession. You and I are really boring, and we always say, "Don't do anything, just ignore it." But sometimes you do have to do something. So, where do we start?

Kemp: Absolutely. And recessions are generally big and quite rare events. And so, it is worth thinking ahead of time. We're not in a recession at the moment as far as we know. So, thinking ahead of time, what you would do as an investor in a recession and preparing accordingly. And the first thing to remember is that recessions can be great times as an investor, because normally prices are lower than they normally are. And so, that gives you an opportunity to buy assets more cheaply and so to sow the seeds of future growth. So, recessions can be a great time. The problem is, they don't feel like a great time to invest. And so, when you have an opportunity to do something, but all of your gut instinct is telling you to do something else, that's normally where we have to guard against behavioral biases, making bad decisions, doing the wrong thing. And so, by preparing ahead of time, if we find ourselves in a recession, then we'll have some rules of thumb in order to help us make better decisions and know what to do.

Black: But that is it. When you're investing you do quite often have to fight your instincts. So, in your head, you're saying, "Sell, sell, sell." But actually, you should probably keep just drip-feeding little bits of money in.

Kemp: That's exactly right. So, lesson number one is to continue to invest. Recessions are very different from market crashes. So, normally, in a market crash, the danger is that you make too many decisions, and you get whipsawed and make a series of bad decisions. In a recession, people normally get a bit bored of investing and a bit fearful and so don't make too many decisions, they actually make too few. They tend to stop investing, because they feel that there'll be a better time to invest in the future. But in reality, some of the best returns are claimed, are achieved during a recession. And so, it's worth staying invested and also continuing to invest new money through a recession.

Black: And one of those behavioral biases is called recency bias, where we all get worried about something that's in our recent memories. And that will be for a lot of people that 2007-08 crash, and we don't want that to happen again. But actually, we should probably be thinking off into the future and concentrating on our goals.

Kemp: That's exactly right. And if you don't have investment goals, it's very difficult to do that. And so, it's really important whenever you start an investment, to think about what the goal of that investment is. If you don't have a goal, then all you have to measure it by is what happened yesterday or over the last year or six months. And as you say, because of something called recency bias, where we tend to expect the near term to look like the recent past, then that can lead us to make some terrible decisions. And so, really important to have an investment goal and to always measure your returns that you're getting for your investment against that goal, see if you're still on track. And if you do that, it's really going to help you to continue to invest through that recession.

Black: But, of course, you shouldn't just buy everything, you still have to pay attention to those fundamentals and valuations. And it's not just an opportunity to go supermarket sweep from the stock market.

Kemp: No, absolutely it isn't. And we are, as you know, long-term valuation-driven investors. And so, value is always at the heart of what we're looking for in an investment. The difficult thing in recessions is that sometimes equity stocks, shares, can appear to be expensive because the profits on which you tend to base your valuation view are depressed. Most companies go through cyclicality, these economic cycles, so at times their profits will be very high, we're seeing that at the moment, and times when they will be very low. And so, when you're looking at a company's share price and thinking about its value in a recession, then be aware that it might look expensive because those profits are unusually low. And as the profits rise as a country or a company recovers from that recession, then what you'll see is that company will actually get cheaper, the share gets cheaper as the prospects often improve. And so, when you're thinking about valuation and recession, you have to think about it slightly differently from valuation when prices are very high.

Black: Well, thanks so much, Dan. Great top tips. And thanks for joining us.