What happens during a recession? Things tend to go pear-shaped. Panic begets panic, and as businesses collapse from a lack of credit or try to save money by laying people off, unemployment rises. That means people have less to spend, which reduces demand, making businesses struggle even more, and so on… In the last recession, around nine million jobs were lost in America alone. 😬

What happens to share prices? A plummeting economy spooks investors, who start to flee volatile investments. Share prices will decline, particularly for companies with high debt levels (investors worry they might not be able to repay their loans and will shut down). Some firms might benefit though, as investors search for safer options: consumer staples like Unilever and P&G are often the last to suffer (their products are necessities). Sectors like utilities and defense also do well – the consistent dividends these areas offer and their stable business models mean they’re sometimes seen as “recession-proof.” 🛡

How about bonds? The riskiest corporate bonds will typically see massive price falls – few investors will be willing to take a gamble. But government bonds will usually see prices rise (and thus yields fall) – countries like the UK and US are extremely unlikely to default on their debt. Not all sovereign bonds are equal, though: in mid-2011, Greek bond yields soared as investors grew scared Greece might collapse. Currencies also tend to fall in value during a recession as capital outflows happen and demand for the currency weakens. Commodity prices can drop too, given less overall economic activity.

All these prices might fall before a recession actually starts – if investors think one is coming, they’ll begin to sell. Ironically, that could itself trigger a recession…

What does this mean for my investments? If you think a recession is looming, you might want to get out of your riskier investments first. But a recession can also be a great opportunity for bargain hunting – a la Warren Buffett. When the market rebounds, you could come out on top by buying shares of good companies at discount prices while everyone else is running away. 😎

That is, if the market does rebound. Next up: how recoveries come about – and how they sometimes don’t.