Why investors should review their portfolios amid recession fears

The world economy is set to face a recession, with inflation on the rise, geopolitical tensions spreading and the global supply chain still struggling to recover.

The probability of a soft landing is unlikely and two to three problematic quarters appear to be looming as central banks continue to increase interest rates to combat inflation. However, that is not great news for riskier assets such as stocks. The interest rate hikes have also affected bonds on the secondary market: their returns are now more palatable and their value has suffered a hit, but this has been reflected in the overall value of even the most cautious existing asset allocations

For more than a decade, stocks were on a bull run, fuelled by expansive monetary policies, both conventional and more “creative”, by central banks. I’ve been critical of these policies as I believe that such a prolonged period of massive stimulus has created a situation in which it has only partly ended up in the real economy, ultimately “doping” the stock market — and all financial markets in general — beyond measure.

The cheap credit also created bubble-like situations in some real estate markets globally, which could, in turn, lead to issues for the banking sector.

In this scenario, wise investors may have continuously rebalanced their investment portfolios to take advantage of the stock market bull run to keep their desired risk exposure, resulting in a rising cash component.

However, it may not have been reallocated to the bond market, as extremely low interest rates typically don't encourage exposure to investment-grade bonds given the risk related to the rise in interest rates.

This ultimately ends with a manageable exposure to risky assets and reduced volatility of returns in the overall portfolio.

So, what must investors do now that stock markets are in bear territory? I believe central banks may have learnt a lesson and might seize the opportunity to normalise their policies, as they are doing with interest rates.

However, interest rates might be close to their peak, as we can see an uptick in unemployment data in the US and news of big players such as Facebook owner Meta planning massive layoffs making the headlines.

In the absence of further shocks on energy prices, this could also affect Consumer Price Index data, which is one of the most important indicators for central banks in their monetary policy decisions and lead them to slow down the pace of rising rates, or even bring them to a halt.

In this scenario, it makes sense to start buying bonds on primary markets in a buy-and-hold perspective and cherry pick bonds on the secondary market, even on a speculative approach.

Investors should consider building this component of their portfolios now — when interest rate rises start to slow, the market will react immediately. As for the stock market, there are already some good buying opportunities in the technology sector, which has been among the biggest losers in 2022.

The excess of cash should be gradually reallocated to seize opportunities that financial markets are offering now and in the future.

Has the risky asset market bottomed? Can we move in and fill up the stock-related part of our portfolios? I still think that there are downside risks to consider, especially if central banks don't indulge in any new “creative” monetary policies.

Therefore, we should resist the temptation of rushing into a buying frenzy to avoid exceeding our comfort zone in terms of risk tolerance. That is closer to gambling than investing — and, more often than not, leads to disappointment.