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Economic Recession Essay

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While it would be Utopian to have the economy grow at a stable rate, economic recessions are a fact of life and are as unavoidable as the setting of the sun. The economy has a cycle that involves both periods of growth and expansion, and periods of decline and recession.

For investors, it 's often the recessionary cycle that causes the most concern. In this article, we will look at how to properly invest as the economy moves through this phase.

Tutorial: Economics Basics

What Is a Recession?
A recession can be defined as an extended period of significant decline in economic activity including negative gross domestic product (GDP) growth, faltering confidence on the part of consumers and businesses, weakening employment, falling real incomes, …show more content…

For example, one of the most often used tools the government uses to reduce the impact of a recession is monetary policy that leads to a reduction in interest rates with the purpose of increasing the money supply, discouraging people from saving and encouraging spending. This helps to increase economic activity.

One of the side effects of low interest rates is that they tend to create demand for higher return, higher risk investments. So, as recessionary expectations bottom out, pessimism fades away and optimism works its way back into people 's minds. Moreover, investors re-examine opportunities for riskier investments in the context of what is usually a low interest rate environment. They also embrace risk.

As a result, equity markets tend to do very well during economic recovery. Within equity markets, some of the best performing stocks are those that use operating leverage as part of their ongoing business activities, especially as these are often extremely undervalued after being beat up during the market downturn. Remember, leverage works great during good times, and these firms tend to grow earning faster than companies without leverage, but they also face real risks during weakening times. Moreover, growth stocks and small stocks tend to do well as investors embrace risk during an economic recovery. (To learn more about operating leverage, read Operating Leverage Captures

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