Members of the Federal Reserve warned last month that there was a 50% chance of a recession in 2024. Likewise, the ongoing layoffs in the tech sector seem to prove that a recession is inevitable. Alright, does that mean more people will lose their jobs? And all market assets are set to fall?
Sun Tzu, the Chinese author of the Art of War, once said, “Know the enemy and know yourself; you will never be in peril in a hundred battles.” To win the “battle”, our MoneySmart team has prepared you with financing tips and investment strategies to get ahead of the game.
What Is A Recession? Why Would It Happen?
By definition, a recession is an economic situation where the national GDP declines for 2 consecutive months in the first quarter.
Why does a recession happen? The simple answer lies in the psychology of public spending.
The negative wealth effect theory suggests that if people expect their income to be cut in the future, they will spend less. And the vicious cycle continues with sales drops, company profit drops, and potential layoffs. In the end, people’s incomes get cut for real, and they have less to spend. This is a self-fulfilling prophecy: when you expect a recession to come, it will come.
What Signals Can We Find Before a Recession Comes?
So, how could you spot a potential recession before it comes? Here are four factors to look at:
Gross Domestic Product (GDP)
GDP measures the national economic output. In simple words, it is a metric to show how much economic activity has been done at a certain time. If GDP is falling for two consecutive months, the country is considered to be in recession.
Retail sales
It is a metric that shows consumer confidence in the momentum of economic growth in an economy. If retail sales are dropping, it might indicate a sign of a potential recession.
Unemployment rate
To sustain retail sales, consumers need a job with a stable income. A high unemployment rate will affect consumers’ spending because they will have less incentive to spend in case they get fired. Then, a recession is expected to set in.
Industrial production index
The industrial production index reflects changes in the production level of industrial sectors such as mining, manufacturing, electricity, gas and steam. This is also a leading indicator of recession. If the output level is expected to drop, GDP will also likely decline because fewer products will be available for sale.
Inverted Yield Curve
A yield curve shows bond market liquidity, which reflects the investor’s confidence in future economic activity.
In a normal situation, the yield curve should be an upward-sloping curve, which means the yield of the long-term bond is higher than the short-term yield. And it reflects that investors have confidence in the economy and invest in the market.
However, suppose investors expect poor economic performance. In that case, they will park their money in a safe place, like U.S. 10-year bonds, for stable yields, which will drive the long-term yield down, and then an inverted yield curve appears.
Are We in a Recession Now?
According to a traditional definition, the U.S. is not currently in a recession. The conventional definition of a recession is 2 consecutive months of declines in economic activity.
The U.S. GDP data released in Q2 and Q3 2023 showed 2-quarters of a growth in GDP. So, the U.S. economy is not regarded as a recession.
How Long Would A Recession Last? How Do You Know If It Is Over?
Okay, what if a recession is already here? Then how long would it last? When can I start to invest in the market again?
Since a recession isn’t something new in history, and we’ve looked back through the historical data, here are some insights:
- The U.S. market has experienced 11 recessions since 1948.
- Modern recessions usually last 17 months since 1854.
- The length of a recession is getting shorter.
- The average American recession has lasted ten months if you only consider the post-WWII period.
What Should You Prepare When Recession Comes?
As Fed Chair Jerome Powell said, “No one knows whether there’s going to be a recession or not and, if so, how bad that recession would be.” So, It’s always wise to prepare for the worst.
Here are a few suggestions for staying afloat during a recession:
Get ready to find a new job
Being proactive and having a backup plan in case of a layoff could be an excellent strategy to stay ahead of the uncertain time. (But I hope you won’t need it!)
Updating your resume is a good place to start, but don’t forget to update your professional connections network, such as calling ex-coworkers or creating a LinkedIn profile. If you’re lucky, you could find some freelancing gigs that secure your financial health along with your job and enrich your resume. This should get you a huge leg up in your career.
Remember to get yourself some additional training when you’re free. Expanding your skill set should keep you sharp in your position.
Prepare an emergency fund for the next 6 months
How much do you know about yourself financially? How much cash do you have on hand? If you lose your job, touch wood, can you live for half a year? During an uncertain time, it’s essential to prepare yourself with an emergency fund that covers expenses for at least 6 months.
If you don’t have one, you can make a budget plan by logging your income and expenses and setting a financial goal to prepare an emergency fund. This can also build a habit of reviewing your financial situation and give you more flexibility.
Repay your loans when possible
Reviewing the outstanding debt balance is good advice for managing your financial situation during a bad economic time. Try your best to pay every bill on time. Otherwise, it’ll leave a mark on your credit scores, and that’s not nice for your future financing.
If you encounter difficulties with repayment, you may consider the following solutions:
- Prioritize bill payment and keep enough cash on hand to cover high-interest debts.
- Reach out to your creditors and ask for hardship concessions. Credit card companies or other financial institutions may offer repayment plans.
- Check out your local bank or credit union for a personal loan to restructure your debts with a lower interest rate.
Invest throughout the recession phase
A recession may not always be a threat to hurt your portfolio. It may also be a chance to grow your wealth, as long as you understand which sectors the money will flow into.
Imagine what it’d be like in an economic downturn: people are losing jobs, businesses are closing, and you’re one of them. How’d you spend your money? You’ll spend less on luxury items and try to save money by switching to a cheaper option, right?
So a company in the “consumer-stable” sector will generate a more stable income flow. Industries in daily necessities like food and groceries will not be heavily affected by the recession because customers will rarely cut expenses on these products.
During an early recession, money tends to flow into more conservative investment instruments like defensive stocks, bonds, utility companies, or commodities. In the later stage, the liquidity will flow to the growth sectors, like technology and innovation, to prepare for the next bull run.
“DCA” your investment during a recession
Dollar-cost averaging (DCA) is an investment approach in which investors invest in assets regularly regardless of the price.
DAC works well during a bear market because it can average the asset’s cost. It prevents us from missing out at the bottom or buying at the top. In the end, it gives a better reward-to-risk ratio.
Pick up hidden gems in a bear market
As said by Buffett, “Be greedy when others are in fear.” A bear market is a great time to buy your long-awaited promising stock with an underprice. You can take advantage of a retail investor, especially the flexibility of market entrance, making a move before the institutions. Once the sentiment is positive, promising projects will be at the centre of attention, all you need to do is be patient!
Final Words: Brace Yourself and Be Prepared for the Ride
The best thing to do during an uncertain time is to be proactive and prepare for the worst scenario. Learning all the need-to-know finance information about recessions and structuring a plan beforehand should take the weight off your shoulders.
As always, “Be MoneySmarter and make your life easier!”
Related articles
Want to stay ahead of the crowd? Visit the MoneySmart blog for more financial tips!
MoneySmart—Your One-Stop Financial Products Platform
Homepage: www.moneysmart.hk/en/