26 October 2022

Insights

Trading a Global Recession 2022/2023

Global recession fears have been growing since 2019 when Covid first hit the global population and consequently the economy. Some economists believe there is a 98.1% chance of global recession, as reported by CNN. The World Bank believes there is an increased risk of global recession in 2023. And the International Monetary Fund (IMF) warned in their latest World Economic Outlook that "the worst is yet to come". So, is it coming and how can you prepare for it?

In this article, we’ll explore the causes of recession and also common practices that will help you plan your own trading strategy for future recessions.

What causes a global recession?

There are so many factors that contribute to a global recession. But rather than giving you a general overview, let’s dig deeper and break it down so you can build a foundation of expertise on this topic.

Supply and demand imbalance

Global recessions can occur when a disruption in the delicate balance of supply and demand occurs. Whenever there’s an imbalance between consumer buying and industrial production, a decline in economic activity follows.

A supply and demand imbalance can disrupt the labor market, making employment reports a strong indicator of trouble. Companies feeling the sudden pinch lower their workforce and salary costs. The unemployment rate rises, spend decreases follow, property purchasing falls, companies go bankrupt, bank debts don’t get paid... and down goes the economy into a seemingly bottomless spiral.

Disappointing revenue reports from the biggest companies can also indicate a downturn. If multiple big corporations all show a drop in sales, then a storm might be brewing on the horizon.

Inflation on the rise

Supply and demand disruptions affect inflation rates. Inflation occurs when products or goods become more expensive. This means that your money is decreasing in value. When a currency devalues, everyone feels it.

Inflation is not a standalone sign of a global recession. But know this, high inflation, even during times of high demand, can still weaken the economy and eventually lead to a recession, when combined with other factors mentioned in this article.

Rising interest rates

Interest rates reflect the volume of floating debt. It’s calculated by the annual percentage of all outstanding loans. When interest rates are low, companies (and people) can afford to borrow more money, and investments in new business stimulate the economy.

High interest rates mean higher debt payments, less cash-flow for spending, and the likelihood of debt defaults rise. Banks compensate their losses by increasing interest rates further… and another downward spiral begins, feeding a global recession.

Volatile political climates

Pandemics and war can destroy our energy infrastructure and strangle supply chains. And of course, when supply chains break, prices inflate. Embargos and other non-unity politics can cause consumer prices to rise, which negatively affects consumer spending.

Governments and economists are constantly trying to tweak the economy and maintain a stable market, but changing one aspect of our financial ecosystem can have untold effects on the others. Sometimes, meddling with the ecosystem, even with good intentions, can have catastrophic consequences.

So, looking at 22Q4, do you see a supply and demand imbalance, increased inflation, rising interest rates, and a volatile political climate? Undeniably yes. All the signs are there.

Trading sentiment can also contribute to a global recession

Regardless of the economy’s health, if world media warns everyone of a global recession, social and market sentiment can crash in less than a week. Imagine surfing through your preferred news channels and trading sites, and seeing stories claiming an economic downturn is here. You might naturally feel apprehensive. Who wouldn't?

Perhaps those fears would dissuade you from trading and possibly delay the purchase of that new car you’ve been thinking about. If everyone feels that way, the world will witness a self-fulfilling prophecy. Everyone gets scared and squeezes their wallets tight, which can trigger a recession.

Right now, financial news sites are only peppering their news feeds with the occasional warning of a coming recession. Traders are now uncertain when and if an economic downturn will occur, so sentiment is fluctuating wildly.

Trading CFDs during global recession volatility

All markets fall during a global recession, sometimes rapidly, and those massive price moves can generate huge profits, assuming the trader is savvy enough to choose the right direction. Of course, those massive moves can also wipe out a trading account in minutes, especially when high leverage is involved.

Direct investors not enjoying the benefits of CFD trading don’t have the luxury of shorting the market, and their losses can be almost bottomless. CFD trading with Exness allows a trader to customize an account’s stop out level, and better protect their equity from a sudden and massive crash or rally. These unique stop protection functions are great for trading the markets, but they are truly priceless during recession volatility.

Stock market: effects of recession

Even a so-called safe haven asset such as gold still involves risk. Gold and oil are the traditional places to park wealth when the economy suffers, but they are extremely unpredictable these days. Traders with a limited budget can stop out in a day, only to see the markets move in the right direction the next day. Very frustrating.

In contrast, stock trading during a recession is slightly more predictable. If another great recession kicks in, we all know which way stocks will go. If you are a stock trader, there are three optimizations to consider if or when a global recession hits. As always, nothing is guaranteed, but professional traders commonly used these practices to minimize trading risk during a downturn.

1. Trading consumer staples

Consumer staples are defensive stocks. These are essential products used by consumers, such as food and beverages, household goods, and pharmaceutical products, even recreational products such as alcohol and tobacco. Defensive stocks usually rise during a global recession, so a well-timed long/buy is worth considering.

2. Trading cyclicals

Cyclical stocks are a reference to companies that offer products and services in high demand during times of prosperity. Cyclicals get hit hard when the going gets tough. Typical cyclicals are restaurant chains, hotel chains, airlines, and car manufacturers. Cyclical stocks are usually among the first to drop during a global recession, so consider a short order.

3. Cash cow stock trading

Cash cows are companies with large cash reserves, which allow them to survive or even prosper during a global recession. They are simply better able to cope with an economic downturn thanks to a huge cash reserve buffer. They keep moving onward and upward, although at a diminished capacity. A long/buy possibility worth considering.

Should you trade commodities during a global recession?

Commodities trading during a global recession is best avoided unless you are an experienced trader. If you choose to trade commodities, be sure to review the behavior history of your chosen asset during the previous downturns, but as the disclaimers read, past performance will not guarantee future results.

Forex trading through a downturn

If you’ve been trading the foreign exchange for more than a decade, you’ll know that forex is far from recession-proof. Countries starting the global recession with high interest rates and other financial struggles are hit much harder than those in a more stable position.

For example, the UK still hasn’t recovered from the Brexit fallout. Consumer goods prices are already rising after leaving the EU’s equitable trading partnership. And, with gas prices at an all-time high due to war, a global recession will probably hit the British economy with ferocity.

Since forex is about pairing currencies, shorting GBP or other weakened currencies against a nation with a stronger balance sheet might be worth considering. Be aware, a central bank or government might choose to shoulder some of the burden at the beginning and artificially cut interest rates, so don’t expect it to be a long straight crash.

The bottom line

Global recessions seem to be a necessity that give our ever-expanding economy a reset. Nothing can grow forever. Those trading for a while know well that what goes up, must come down… once in a while. Recessions create a new equilibrium or foundation from which to build again.

Global recessions are coming around more frequently than ever before in history, but the good news is they seem to end quicker too. Governments, the Federal Reserve, and big banks have learned from previous downturns how to recover, so the next one might only last for a year… maybe less. So no, it’s not all doom and gloom after all. Just be ready to take every advantage that comes your way.

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