A RECESSION IS COMING

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The word “recession” captures attention and mind-share like few topics in the world of finance and investing. Whenever it is mentioned or written, everyone listens just a bit more closely.

The definition of a recession is multi-faceted. There has been a degree of debate about the formal, academic definition of a recession in recent months.

A favorite resource, Investopedia, puts it simply, “A recession is a significant, widespread, and prolonged downturn in economic activity.”

The dispute is centered around a rule of thumb in identifying a recession. Is two consecutive quarters of negative GDP growth a recession? This has been generally accepted in the past. Recently, the National Bureau of Economic Research (NBER) provided some additional guidelines about identifying a recession.

The NBER definition includes additional insight, “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

This mouthful from the NBER is more detailed than the traditional rule of thumb. Many folks see conditions indicative of a recession and have started to make predictions for 2023.

It has been previously discussed how professional investors enjoy making recession predictions. The list of high visibility market commentators predicting a likely recession has grown. The American public via survey believes a recession is likely. In short, people are generally pessimistic about the short-term future of the US economy.

If a recession is inevitable at this point, you should understand how it might impact you and your family. Although there is little any individual can do to entirely avoid a recession’s effects, a steady strategy and state of mind can be useful in the midst of a market downturn.

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What are the impacts of a recession?

The length of a recession will be especially important in determining its overall impact. Averages are not particularly useful in this case, but the NBER marks the average recession since WW2 at approximately 10 months.

Most people can endure a relatively short recession, but a longer period of time in a recessionary environment can be especially painful

If you were trying to sell a home during the 18 months in the Great Financial Crisis, you definitely felt serious effects from the recession. This was a long recession. In contrast, the two months of the Covid Crash could easily be endured, especially for those individuals in certain sectors not requiring significant amounts of in-person activity.

Generally speaking, a recession’s impact is seen in a few ways.

Increased unemployment is a recession indicator. During a recession, companies may freeze hiring or undergo a series of layoffs. This limits the availability of jobs and could increase the number of people looking for a job.

Inflationary pressure is a key recession marker. The price of goods and services would be expected to rise during a recession due to limited availability or slowing output. With rising costs, the monthly cash flow of your business/individual household may be squeezed, causing some amount of pressure within your business activity or in your family’s lifestyle.

General volatility in the stock market may be another impact of a recessionary environment. Everyone remembers the slow grind downward in asset prices in 2008. The wild market swings in 2020 provide ample evidence of recession’s volatility.

In and of itself, volatility is not a headwind, but it is nearly always present in a recessionary market.

Some impacts of a recession are always unanticipated or unknown. These are the areas where business owners and individual investors should be especially wary. The reaction to a recession’s impacts will be especially important.

Who is impacted by a recession?

A recession will impact nearly everyone in some way or another.

The most harsh impact will be for those who lose a job. The challenge of unemployment is especially unenviable. If the timing is right, you may be led to retire or seek an entirely different type of position, the work-optional or part-time gig we have discussed previously.

If someone in the early or middle stage of professional life is out of work during a recession, finding employment becomes an utmost priority. The long-term view of a financial plan is dependent on

The inflationary pressure will impact everyone’s bottom line - businesses and individuals alike. When the cost of producing goods and services increases, a business must take a hit to the bottom line or raise prices. The end consumer then pays this incremental cost and will have less to spend elsewhere.

The inflationary cycle is difficult to break. We have seen its effects in 2021 and 2022, as businesses and consumers battle rising costs. In a recession, inflation’s impact becomes especially apparent.

The volatility in financial markets is more of a nuisance than a true impact. After all, sellers are the only individuals who realize a loss.

It may be difficult to watch your portfolio decrease in value, but a seller of a financial asset experiences the harshest impact. If you weather the storm and allow markets to recover, a recession will simply be a blip on the radar.

What can be done to prepare for a recession?

While a recession will never be a pleasant experience, you don’t have to sit back and take the full brunt of the attack on your wealth. Despite the disagreeable nature of a recession, it is a regular component of a healthy economic cycle.

It won’t last forever and usually provides a needed release for the economy as a whole. It’s a critical time to step back and refocus your efforts on building wealth in the long-term.

1/ Don’t panic

Panic can take on several forms. There are those who see turbulent market conditions and aggressively make portfolio adjustments. Then, there are those who hear a recession forecast then ruthlessly cut back on spending and other components of lifestyle.

Either method of panic is not particularly useful or beneficial. A wise business owner or individuals applies some caution to their activity during a recession but still applies the same discipline.

2/ Examine cash flows

We regularly discuss the importance of cash flow. In the larger scale of a business or in a personal financial plan, cash flow is king.

For those in retirement or a work-optional (financially independent) condition, cash flow climbs the list in order of importance. When you are dependent on retirement accounts for cash inflows, you are dramatically reducing your exposures to the market each time you sell shares for living expenses.

In a downturn, the same amount of income will result in selling more shares of an ETF or mutual fund. This is detrimental to long-term wealth building.

Every month there are cash flows in and out. During a recession, it becomes increasingly important for in-flows to exceed out-flows. You may need to carefully adjust spending habits or modify long-term plans to ensure you will have more cash coming in than going out.

3/ Buy assets at discounted prices

Imagine how excited you are whenever you receive an email or hear that your favorite store is having a sale. The embedded ads yell from your inbox, “25% off site-wide!” or “BOGO all items!”

When this comes to your attention, you (just like me) are probably thinking, “Let’s go! I already wanted some stuff from {insert store/brand}, and now it is all on sale!”

By definition, the market will be discounted during a recession. For folks with years until retirement, a recession is just a sale on financial assets. It is a time to be excited!

There are few good reasons to sell financial assets, but many folks/funds will sell in the midst of a market downturn. Instead of selling at a discount, take advantage of the opportunity to buy financial assets on sale.

4/ Stay focused on long-term outcomes and the future

Does anyone regret the shares of an ETF or mutual fund purchased at discount? Does anyone feel poorly for buying a yield-producing property or profitable business after the crisis?

The cool heads prevail in the midst of the recession by taking advantage of it.

You, your financial assets, and your business can be tossed about in the short-term. Choppy markets and a recession provide a serious headwind.

In the long-term? You are the most important factor. The habits/character of the person in the arena are almost always more important than short-term environmental factors.

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TL;DR

It seems like there is always a recession on the horizon. People will always want to make forecasts, and it seems like a recession forecast is a favorite.

Your wealth building journey will always have hurdles. Any recession you encounter is simply another challenge to overcome.

When you refuse to panic and stay focused on the long-term, you seriously deafen the blow of any recession.

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Have you heard someone fearing an impending recession? Quiet their fears by sharing this article with them.

You will look like a cool head in the midst of the crisis!