Are Stocks a Better Investment Than Bonds in a Recession?

A global recession could be near, as war keeps energy and commodity prices elevated and as interest rate hikes affect demand. Where should you invest?

| More on:

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn more

Recession and stagflation are all over the media. The World Bank and the Organization for Economic Cooperation and Development have reduced their global growth outlook, warning of a risk of stagflation. Stagflation is one of the worst economic conditions, where economic growth stagnates and prices (mostly raw materials) continue to rise. Does it ring a bell? 

The current scenario hints at stagflation in 2022/2023 and a recession in 2024

Rising oil and gas prices due to the Russia-Ukraine war are increasing the prices of other goods. Essential items are becoming expensive, leaving little in the hands of low-income groups to spend on discretionary items.

The University of Michigan’s Consumer Sentiment Index stood at 50.2, its lowest since 1978. Such low confidence doesn’t come overnight. Probably it has been in the making since September or November 2021, when tech stocks, especially e-commerce stocks, started decelerating. Even then, the economy has been holding up well. Consumer demand recovered in some industries like airlines, as consumers used their pandemic savings. Moreover, a strong labour market kept the economy from falling into a downturn. 

But unemployment rates are rising, savings are drying up, and the supply chain disruption shows no sign of easing prices. The result is a slowdown in consumer spending, leading to stagflation. The central banks are hiking interest rates at an accelerated pace to curb inflation, but this has started to affect consumer demand. With borrowing costs rising, people have lower liquidity to spend. 

At this point, the economy is at the start of stagflation. The only way to control stagflation is to boost production. The war has disrupted the global supply chain, and COVID lockdowns in the world’s biggest manufacturer China have made it difficult to boost production. Hence, the effects of stagflation are seeping in.

If the central bank continues to hike interest rates, it will be difficult for an average consumer to thrive, thereby reducing demand. This demand shock will start reflecting in companies’ earnings and push the economy into negative growth, leading to a recession. 

“From a timing standpoint, we do not have a recession call on the table for this year. Our models are suggesting that 2024 is the more likely recession timetable.”

said Federated Hermes chief equity market strategist Phil Orlando

What is the best investment in a recession? 

Mild or severe, a recession is very likely coming. While the above are U.S. figures, history shows that the Canadian economy is closely related to its neighbour. A recession in the United States could result in one in Canada, as the former is one of the biggest export markets of the latter. 

What is the best investment option in a recession: stocks or bonds? Treasury bonds are considered to be risk free, but they give low interest. The 10-year U.S. T-bill gives 2.46% interest. This return is losing you money in an inflationary environment of 8.6%. Even if inflation eases, the 2.46% interest won’t be enough to meet the rising prices 10 years from now. 

On the contrary, stocks are volatile in the short term. The demand shock will likely seep into the business cycle and pull down the economic growth. The equity market could fall. But unlike bonds, businesses can adapt to changing business environments, for they work with the sole objective of making profits. When inflation rises due to a growing economy, companies can pass on the cost to consumers and grow alongside demand. In the long term, stocks could beat inflation and generate wealth. 

Which stocks to buy? 

Which stock should you buy in a recessionary environment? The lowest-risk equity investment is in index funds, which track top companies by market cap. Some companies may perish in the recession, and some may flourish. Index funds can replace perished companies with the flourishing ones, keeping you invested in market leaders for a minimal cost. 

Horizons S&P/TSX 60 Index ETF (TSX:HXT) is my choice because it has one of the lowest expense ratios of 0.04%. This ratio is way below iShares S&P/TSX 60 Index ETF’s 0.18%. A 0.14% difference might look small now, but it compounds into a huge amount as your portfolio grows. Apart from an index fund, a defensive stock like Descartes Systems is a good fit. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

 Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.

More on Stocks for Beginners

Stocks for Beginners

New Investors: 3 Top Dividend Stocks to Start a Simple Portfolio

These quality dividend stocks are worthy for new investors to consider for a simple passive-income portfolio.

Read more »

Make a choice, path to success, sign
Stocks for Beginners

New to Investing? Here’s How to Not Lose Money

One way to avoid losing money in the stock market is to stick to broad market index funds like iShares…

Read more »

Knowledge concept with quote written on wooden blocks
Stocks for Beginners

An Easy Way to Understand a Recession

Are recessions good or bad? It depends on how prepared you are for one. Here’s what a recession does to…

Read more »

analyze data
Stocks for Beginners

New Investors: Start a Portfolio With These 3 Stocks

Are you a new investor looking for stocks to add to your portfolio? Here are three top picks!

Read more »

protect, safe, trust
Stocks for Beginners

2 Safe Stocks Beginners Can Buy for Reliable Passive Income

If you are a beginner investor looking for safe, reliable passive income, I've got two TSX stocks you can rely…

Read more »

Stocks for Beginners

Investing Strategies for Canadians in an Uncertain Economy

These are uncertain times, as the economy grapples with high inflation. Here are four investing strategies for the current market.

Read more »

Stocks for Beginners

How to Start Investing in a TFSA in a Down Market

Are you interested in starting a TFSA during a down market? Here are a few tips to keep in mind.

Read more »

Make a choice, path to success, sign
Stocks for Beginners

TFSA Investors: Must-Have Stock Strategies for Your Retirement

While reliable income stocks could help TFSA investors reduce their risk profile, high-growth stocks have the potential to significantly multiply…

Read more »