Learn to play with stock Market Recession

by Leplan on February 1st, 2010

A recession is when GDP growth slows, businesses stop expanding, employment falls, unemployment rises and housing prices decline. The National Bureau of Economic Research (NBER) is an organization that is seen as having the final word in determining whether the United States is in recession. It has a more extensive definition of recession, which deems the following four main factors as the most important for determining the state of the economy:

Employment
Personal income
Sales volume in manufacturing and retail sectors
Industrial production

According to Ben Bernanke, the Chairman of the Federal Reserve, the stock market recession on 1929 was one of the main causes of Great Depression.

Bernanke relates several key actions by the Federal Reserve when discussing recession:

The Fed began raising the Fed Funds rate in the spring of 1928, and kept raising it through a recession that began in August 1929. This led to the stock market crash in October 1929.
When the stock market crashed, investors turned to the currency markets. At that time, dollars were backed by gold held by the U.S. Government. Speculators began selling dollars for gold in September 1931, which caused a run on the dollar.
The Fed raised interest rates again to try and preserve the value of the dollar. This further restricted the availability of money for businesses, causing more bankruptcies.
The Fed did not increase the supply of money to combat deflation.
As investors withdrew all their dollars from banks, the banks failed, causing more panic. The Fed ignored the banks’ plight, thus destroying any remaining consumers’ confidence in banks. Most people withdrew their cash and put it under the mattress, which further decreased the money supply.

Recession in stock market generally means the stock prices continuously fall regardless of company’s strong fundamentals. General fall in all stock prices pull down the index. But, what’s an investor to do during recession? Unfortunately, there is no easy answer. Understanding the business cycle doesn’t matter much unless it improves stock’s portfolio returns

Experienced investors can also make money in recession; bear market does not mean there are no ways to make money. Some investors take advantage of falling markets by short selling stocks. Essentially, an investor who sells short profits when a stock declines in value. But the problem is, this technique has many unique pitfalls and should be used only by more experienced investors.

Another breed of investor uses recession much like a sale at the local department store. This technique involves looking at a fallen stock not as a failure, but as a bargain waiting to be scooped up. Knowing that better times will eventually return in the economy, value investors use bear markets as buying sprees, picking up high-quality companies that are selling for cheap.

There is yet another type of investor that suits in recessionary time. A follower of the long-term, buy-and-hold strategy knows that short-term problems will barely be a blip on the chart when taking a 20-30 year horizon. So one can buy and hold stocks for longer horizons.

Of course, many investors don’t like to go for riskier techniques like short selling or the time to analyze stocks like a value investor does. The key is to understand the situation and then pick a style that really works. For example, if one is close to retirement, the long-term approach definitely is not for him/her. Instead of being at the mercy of the stock market, s/he can diversify into other assets such as bonds, the money market, real estate etc.

People can choose from various market investment areas like Insurance (life insurance, ULIP), Mutual funds, Metal Commodities, Real Estate etc. Its best to diversify after a good financial planning. Taking too less risk is not good either as inflation may overdo the gain. So its always smart to take huge risk but calculated one.

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