We are now over a month into the global COVID-19 pandemic, and with no signs of slowing down, fears are rising of a potential economic crisis. Calls for isolation and quarantine of select regions have investors spooked and stock prices tumbling at record speeds. We have made our way into a Bear market territory with stocks down more than 20% from their highs, marking an end to the bull market’s 10-year tenure while quickly on our way to technical recession territory. Are we ripe for a recession? Keep reading for our thoughts.
Positive Signs for the Economy
Whenever you hear the term “recession” you probably think of two years, 1929 and more recently, 2008. Throughout history, there have many financial crises and they all have one thing in common, we got through them. Despite how negative the economy may turn, a recession will bottom out at some point, giving hope to many.
Valuations Aren’t Stretched
Whenever a recession occurs, you’re likely to find many problems below the surface of the issue. In 2008, it was banks. Banks were lending money to anyone they possibly could. As it turns out, many of these individuals were highly risky and should not have been approved for the mortgages they received. When the mortgage bills started to come, they routinely were not able to pay for them, triggering a sudden shock to the financial system.
Then it got worse. Many of these mortgages were packaged into financial products known as CDOs (Collateralized Debt Obligation). Investors were able to purchase swaths of mortgages with (what they thought) was extremely low risk. To quote the Big Short, “Well, they’re mortgages. And who the hell doesn’t pay their mortgage?”
As it turns out when mortgages were not paid, not only did it affect the banks, but anyone who invested in the CDOs were also in trouble.
Whenever the stock market becomes overvalued, there is a fear that something similar might be occurring. S&P 500 companies routinely trade at around 15-20 times earnings, with the average being 15.78. Currently, the market is trading at around 20 times earnings. This means that stocks are not extremely overvalued, which is a good sign for the economy.
Consumer Wages & Confidence Have Steadily Increased
Unemployment has been at record lows over the past few years. With that comes strong wages and discretionary spending. American’s are spending more than they ever have, which is great for business and the broader economy.
Wages remain strong and have been rising steadily over as of recent. Wage stagnation is commonly associated with a recession. While this is a good sign for current economic conditions, slowing wage growth and unemployment could point us in a different direction.
The United States government is aware of what is occurring and evolving on a minute by minute basis, and that includes the economic impacts. The Federal Reserve recently injected the financial markets $1.5 billion in stimulus to keep banks flowing with cash. In addition, all feral student loan interest payments have been halted, giving those who are cash strapped a break from paying on student loan interest.
If the virus continues its path of destruction, we can expect the government to announce large scale financial stimulus for both the working class and business owners alike, giving a reason for hope for the markets.
What We Don’t Like
Recessions tend to be cyclical. On average, once every 3.5 years, the stock market plummets at least 20% or more. And to be quite honest, it’s been a while. In 2018, markets plunged 10% as fears of a trade war took center stage. Before that, it wasn’t until the Great Recession from 2008 to 2012 that stocks tumbled that drastically.
Possible Isolation or Quarantine
As the rapidly spreading coronavirus continues its trek across the globe, some countries have started to adopt quarantine and isolation practices to slow its spread.
In Italy and Spain, a countrywide ban on travel and small gatherings has been initiated leaving many restaurants, fitness centers, schools, and other public places with closed doors and empty parking lots. Many countries have now declared national states of emergency as the virus continues its spread. This could have enormous impacts on both local and global economies.
Travel and leisure companies account for a large majority of the United States GDP and the service industry has been on a roar as of late. A sudden halt to these industries could cause a tailspin of events across the economy, starting with layoffs, triggering a true economic crisis.
Decreased Consumer Spending
The broader economy can often be described as a game of dominos, all it takes is one small event to tump over the first domino. For the past 10 years, consumers have been the leader of the economy, spending money and generating profits for corporations. This consumer spending is capable of covering up larger problems in financial systems such as those that occurred in 2008.
The problem? We have never seen such a widespread virus outbreak since the Spanish Flu in 1918 keeping in mind that containment was much easier without mass travel availability. If a countrywide lockdown is put in place, you could think of the game of dominos in which all pieces are knocked down almost immediately, not requiring the true domino effect to cause economic devastation.
Profound National Debt
The debt of the United States is at an all-time high. Over $23 trillion is owed to other countries and the general public to fund the nation. This is an area for concern that no-one likes to address. It is certainly the elephant in the room and while this alone might not be enough to trigger an economic crisis, it’s something to keep in mind.
Possible Rising Unemployment
As the virus spreads and companies are forced to close, we can expect unemployment to tick up. This might be just one of the dominos that cause the economy to start tipping. With higher unemployment comes decreased consumer spending, which in turn, leads to even higher unemployment.
Current Low-Interest Rates
Monetary policy is limited for the United States. After several rate cuts this year, the Fed is running out of ammunition to combat any sort of economic crisis.
Whenever you hear that the Fed has “lowered rates” this effectively lowers the interest rates in which banks can borrow money overnight to meet federally mandated restrictions on cash reserves.
These interest rates are in place for several reasons with one of the top reasons to control the rate of inflation. The Federal Reserve of the United States has a goal of achieving 2% inflation annually. By adjusting rates, they can stymie or stimulate the economy with cheaper lending options.
For example, a corporation that is growing might not want to take out a loan to grow their business if the interest rate is 11%. However, if the interest rate is 2%, they might be encouraged to spend more. This is how the Fed can use monetary policy to affect the economy.
Today, interest rates are low. This means that we do not have much ammunition to trigger economic growth. With many countries providing negative interest rates (yes, negative), the US might be forced into the same hole is economic prosperity does not pick up.
Other Economic Uncertainties Could Spawn Complications
Unfortunately, the coronavirus is not the only recent news piece that has caused turmoil among the major markets. Oil, politics, and several other events have spurred even further economic uncertainty among investors.
The Oil Wars are Here
Do you ever wonder what causes the price of gasoline to fluctuate so much? It’s all about supply and demand. Each day, the world pumps out around 94.72 billion barrels of crude oil. A majority of this oil will then get refined into gasoline.
Who controls how much oil we pump? There are a few main parts of the global oil supply. OPEC (Organization of Petroleum Exporting Countries) with some American companies, for the most part, determine how much oil we gather.
OPEC is made up of 15 different countries including Saudi Arabia, Venezuela, United Arab Emirates, and several others. These countries gather together to discuss the global oil supply and demand and set limits on how much oil they will pump. Recently, there has been a conflict between some of these countries and Russia on how much oil to pump. An agreement was not reached to limit how much oil is being produced.
Because travel to many countries has been either suspended or discouraged, the use of gasoline has fallen over the past few weeks while the production of oil remains steady. For this reason, oil prices have plunged dramatically, as much as 25%.
What does this mean for US oil exploration companies?
Because of falling oil prices, some US companies have taken a major hit. Companies like Chevron, BP, Exon Mobile, and many others have tumbled more than 30% over the past week.
Many of these companies cannot remain profitable with current prices. That means, for each gallon of oil produced, there is a good chance the company is losing money at current prices. This could trigger major decapitalization and layoffs among these companies, furthering the economic impacts of the coronavirus.
What does this mean for consumers?
There is some good news for drivers across the country, because of falling oil prices, you can expect some relief at the pump. Analysts have noted that gasoline prices can fall below $2 per gallon in many regions, prices not seen since before 2005.
The question then becomes, “what happens to this money”? Some economists are expecting this money to sit in a savings account until economic fears are subdued, while others predict increased spending.
Recession-Proof Investment Strategies
Recessions fears can bring out the worst of us. Even the most notable investors might be tempted to diverge from their traditional strategies in hopes of preventing further losses. However, this is a proven way to obtain lackluster returns limiting any potential gains.
Avoid Panic Selling
Whenever people are fearful, they sell their investments to hold something deemed safer, like cash. This flood of selling in the market can cause the value of your portfolio to drop dramatically and rapidly.
Whenever you panic sell, there’s a chance you might be losing out on any potential gains that come after your sale.
Realize that No Investment is 100% Safe
People often think that cash, US treasuries, and gold are completely safe. And this is not completely true. ALL investments come with some sort of risk, even if it is extremely low.
But there is ONE investment that is safe. Your knowledge. What you learn cannot be taken away from you, so investing in yourself should be a priority during times of uncertainty.
Keeping your investments well diversified is one of the all-time greatest ways to keep your investments steady. By holding various types of assets, you can limit losses in one area (stocks) with the potential of gaining value in another (gold).
Diversification does not guarantee a return, however. Just as discussed above, no investments are 100% safe, meaning that even if your portfolio is perfectly diversified, there’s a chance you could still be losing value.
Take Advantage of Low Rates
As mentioned, interest rates are at historic lows. This might be a good time to use this to your advantage. Starting the business you’ve always dreamed of could be cheaper than ever given current conditions but you should always be careful and have a plan to ensure your business’s success.
How to Prepare Finances for a Recession
If a recession does occur, you need to be financially prepared. This means having a savings if needed or multiple income streams if one is unavailable.
Ensure a 6 Month Emergency Fund (Or Any Emergency Fund!)
When preparing for a recession, you should ensure that you have a way to pay for your monthly expenses assuming that you are out of a job. In 2010, unemployment was near record highs at almost 10%. Would you be able to afford your monthly expenses without an income? If not, it’s time to start saving. It’s unlikely that you’ll be capable of saving 6 months of income in a couple of months, but any emergency fund is better than no emergency fund.
Create Multiple Income Streams
If you work a typical job, this is your time to establish a second stream of income. It could be renting out part of your home, or creating a blog, there are many different income streams you can build to supplement your current income today.
Many passive income streams do not require work at a physical location, giving you flexibility even if an economic downturn occurs.
Cut Spending, Then Cut Again
If you can’t raise your income, you’ll need to cut some of your expenses. It might be eliminating your cable television, saving money on gas, or something as simple as eating out less, you need to ensure a positive cash flow at the end of each month. Creating a monthly budget (if you haven’t already) is essential to keeping a positive cash flow.
You should look for any unnecessary spending and plan to eliminate or decrease the amount you are currently spending. Coffee shops, brand name groceries, and new clothes are some of the easiest things you can eliminate.
Consider Refinancing Debt
As mentioned above, interest rates are at record lows, and that includes interest rates on mortgages and student loans. Now might be the perfect time to consider refinancing, especially if you’re dealing with a less than ideal budget.
There is no sugar coating it, an economic recession leads to stress, fear, and even death among some. Even worse, the health impacts of the coronavirus are inevitable. During this period of time, nations will need to come together to combat this virus to ensure both economic and health prosperity.
Do you think we are headed towards an economic recession? Comment below!
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