Recession is looming — is it time to invest in the stock market?

Closeup of "interest rates" text in a newspaper

Yesterday, the Bank of England announced it was hiking interest rates again, this time by 0.5%, the largest jump in over a quarter of a decade. The rise came after the months of red-hot inflation, which reached record highs of 12.7% in June, fuelling the cost-of-living crisis. The FTSE 100 dropped 0.77% on the news.

The Bank also warned that the UK could be headed towards a long recession, inflation could creep past 13%, and the UK economy would contract by a sizable 2.1% by the end of 2023. This all sounds pretty scary, but I’m using it as a chance to buy more shares in the stock market at bargain prices. Let’s take a closer look why.

The story so far

The UK economy has been seeing rising inflation for months now. Initially caused by the fiscal stimulus and supply bottlenecks of Covid-19, the tragic Russia-Ukraine conflict has magnified the issue, sending energy prices through the roof.  The way that central banks control inflation is to raise interest rates. This dents spending, slowing economic growth. When rates keep rising, eventually GDP growth turns negative, and the economy slips into recession. This is what we’re seeing with the UK economy.

When interest rates rise, stocks tend to fall. This is because people have less extra cash on hand to invest in the market and because they can earn a higher ‘safe’ return on their savings (1.75% from yesterday). It also makes it harder for companies to grow, as consumers tend to buy less and it’s more expensive to raise capital. Stocks have taken a hit across the board, with the FTSE 100 down 1% year to date, and almost 2% in the last six months. Across the pond, the situation is even bleaker, with the S&P 500 falling over 13% year to date, and 6% in the last 12 months.

Why I am buying shares

Such a climate may deter investors from buying shares. However, I think now could be a great time for me to build a dirt-cheap portfolio. Stock prices have taken a hit across the board, yet not a lot has actually changed within companies. This means I can buy some quality companies, at discounted prices.

The FTSE 100 average price-to-earnings (P/E) ratio is currently sitting at 14. A year ago, this figure was much higher, around the 22 mark. Even before the pandemic, the average P/E ratio was around 17. Quality UK stocks like BT, Lloyds, and Barclays are all trading comfortably below 14, looking like bargains to me. As stock prices fall, dividend yields rise, which is also good news.

Therefore, I’m currently on the hunt for undervalued companies to add to my portfolio. While some may be panicking about a recession, I’m using this time to grab cheap shares for long-term growth.

The post Recession is looming — is it time to invest in the stock market? appeared first on The Motley Fool UK.

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Dylan Hood has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group and Barclays. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.