The news and economists are priming our country to expect a recession. The article, “‘All but set in stone’: More economists join chorus predicting a Canadian recession” Financial Post, September 19, 2022, outlines predictors for a recession. What does it mean for Canada to go into recession? How will it impact our lives?
What is a recession?
A recession occurs when a country’s economy shrinks in size for two consecutive quarters (6 months) and is usually measured by a smaller GDP (Gross Domestic Product). On average, a recession occurs once per decade.
Why do recessions happen?
Most often recessions happen when there is high inflation, people are spending too much money, and governments want to cool the economy. Governments generally cool the economy by making people’s debt more expensive which decreases the demand for goods and consequently reduces inflation. Because Canada has a high level of personal debt, when interest rates increase, people need to put more of their earnings towards paying the interest on their debts.
Recessions are stressful, so why would governments want to go into recession? Governments trigger a recession because high inflation is even worse and one of the only ways to kill inflation is to go into recession.
Two bad things about inflation:
- You can’t buy as much, so your quality of life goes down
- A dollar doesn’t buy what it used to. Remember gas at 0.39/litre? Ask anyone who grocery shops or goes to a restaurant how they have experienced inflation recently
- Your savings are reduced
- If you hold cash, it will be worth less tomorrow than it is today
- If you are interested, here are some nasty examples of countries with out of control inflation
Sometimes recessions happen because of an unexpected world event. A great example of this was the financial crisis of 2008. Inflation wasn’t high but because of greed in the financial markets, much of the world went into a recession.
How do we know we are in a recession?
Most of us don’t watch our country’s GDP but there are other signs that tell us we are in or about to enter a recession.
Signs to watch for:
- There is an increase in unemployment
- People are spending less
- Interest rates may have been increased by the government for a period of time
- Stock markets trending downwards
- Real estate demand is decreasing
- Bonds may decrease in value because interest rates are going up
The current expected recession may occur as a result of high inflation so we will spend the rest of our time discussing this source.
What financial actions should you take to prepare for a recession?
- Reduce Debt
- Pay down as much debt as you can
- Consolidate debt into a low interest rate loan
- Set aside additional cash in reserve in the event you lose your job, or your business needs some extra cash
Be prepared to capitalize on opportunities
Yep, you read it right…opportunities. Whenever bad things are happening around us opportunities arise. A recession is no different, the challenge is knowing when the opportunity is right to capitalize on recessions. Remember the signs of a recession: stock markets go down, bonds go down, and real estate drops in value. Watch for indicators which often tell us before other things where the economy is heading:
- Stock Markets recover – Stock markets are seen as a leading indicator that we are near the end of a recession. When the stock market starts to move up consistently, odds are we are moving out of a recession.
- Bond Yields are healthier – Often bond interest rates are at their highest at the beginning of a recession. Why does this happen? The government has raised rates to curb spending. For those who are savers, higher interest rates reward them for having extra money as they now get paid more to lend their money out by investing in bonds.
- Real Estate demand recovers – During high inflation, rents are increased to offset higher costs to the landlord and real estate values drop as people can’t afford to pay as much for property. When a recession comes, a few things generally happen with real estate prior to a recession coming:
- Rents increase
- Real Estate prices drop as interest rates increase
When an economy goes into recession the following generally happens with real estate
- Rents stay at the higher amounts
- Real Estate values go up because of two things:
- Rents are higher which rewards investors when they buy
- Governments stop increasing rates and often start to reduce interest rates to kick start the economy, which reduces the cost to investors
How do you know when to capitalize?
You don’t always know, and you won’t always get it at the very best moment…and that’s ok.
Often when things seem the worst is when it is the most opportune time to capitalize on the opportunity. I remember back on March 9, 2009, a Forbes article summarized the situation well. The question was asked, ”How low can stocks go?”
It wasn’t an idle question. The Dow was on its fourth straight week of losses, while the broader S&P 500 was below 700 for the first time in 13 years. Goldman Sachs put out a research report that warned the S&P could fall as low as 400.
A year later, we know that March 9 was the bottom of a months-long financial panic that wiped away trillions of dollars in assets. But on what now appears to have been the best buying opportunity of a generation, many only wondered how much lower the markets would tumble.[i]
I remember that day (March 9, 2009). I had been in the industry 5 years, and it was my first recession as an advisor. And while in the end I chose to go with logic that “this too shall pass”, I remember my emotions churning, my stomach in knots and thinking, “What if it is different this time?”. But it wasn’t different, and it did pass.
Depending on your stage of life (retired, young, middle age), your strategy to capitalize on a recession will be different. If you are retired, it is more about capital preservation and cash flow, not capitalizing on opportunities.
Here are 3 things that I would recommend if you have low to no debt, have a stable job and good free cash flow that you can use.
- When the market goes into correction territory (down 20%), consider increasing/starting a monthly deposit into your investment account. Talk with your team of professionals to see if they are seeing good value in the investment markets. They are more in the know than you would be. It may not be the bottom but these purchases most likely will look pretty good in a couple of years.
- Invest in assets that generate good free cash flow. Often, businesses that are publicly traded (stocks) that have good free cash flow pay a dividend and the really good ones increase those dividends over time. This type of business is helpful in recessionary markets.
- Invest in Bonds. When it looks like interest rate increases have stopped and signs of recession are all around, bonds can be a good investment. Why? Bonds purchased near or at the peak of inflation will look really good to other investors when governments start to lower interest rates to kick start the economy again.
Summary
Both high inflation and recessionary economies are tough to go through. Stay disciplined, talk with your financial professionals, and implement a plan best suited to your current situation and financial plan.
References
[i] https://www.forbes.com/2010/03/06/march-bear-market-low-personal-finance-march-2009.html?sh=4a6051b23a13
