The R Word...Financial Planning During Recessions

Markets have been really volitile over the past week and "Recession" has been one of the most searched terms online. But what actually happens during a recession? Are we headed for another deep crisis? Can the talking heads on TV actually predict where we are going? In this episode we discuss:

• What actually happens during a recession?

• How do we know if a recession is coming...can we predicit it?

• Do we have conditions for a recession to occur?

• What should investors do if the economy slows down?

Transcript:

 Hey friends. Welcome to the Six Figure Investor podcast. Today we're gonna be talking about what's top of mind for everyone. Can you guess what it is? That's right. It's the R word recession. Brian was telling me earlier today that recession is one of the top 10 Google search terms over the last few days, which is not surprising based on the performance in the marketplace.

And we're gonna be talking. All of that on today's episode.

Hello and welcome to the Six Figure Investor Podcast. Are you a professional who wants straightforward, trustworthy financial strategies that you can act on? Are you entering your highest income earning years and discovering that your personal finances are becoming too complex? We get it. You're a highly competent.

But you don't have time to go deep on your personal finances the way you do with your day job. Hi, I'm Brian, and helping professionals make smart financial decisions is my passion. I run a financial advisory practice called the Capital Stewards and work with professionals like you who are trying to cut through the noise.

It's time to stop googling every question you have about money and dive into some real professional. So let's get moving.

All right, friends, welcome back. As I mentioned to the show opener, today we're gonna be talking about dun dun, dun. Recessions recessions, dun dun dun. They're all over the news. They're all over the Google search engine, so we figured we might as well talk about it. Yeah, and I think it's an, a topic too that is easy to misunderstand and, and as just human emotion goes, I think it's easy for us to go from, from zero to negative a thousand and, and think the world's gonna come apart if we have recession.

So I think it's just an important topic to talk about, understand what recessions really are, what happens and what that means for six figure I. . Yeah. Why don't we start by defining what a recession. The, the National Bureau of Economic Research is actually responsible for determining when we enter an exit recessions.

Of course, there's a government agency for this, and they do this after the fact using data, so they don't actually predict them ahead of time. They only tell us that we've been in a recession or we are in a recession. That started a while ago. So there's a little bit of sort of this backward looking bias in there, and economists believe that the.

ER uses a technical definition of two quarters of negative GDP growth, but they have some sub subjective flexibility as well. So it's not automatic that if there's two consecutive quarters of negative GDP growth, we will be in a recession. But that's generally thought to be what they use to define recession four, babe.

Come on, . For most normal people who don't pay attention to the N B E R and their recession forecast, a recession is just a slowdown of economic activity where the economy stops growing and it actually declines a little bit in, in production and spinning. Thank you. That's what a recession is like the end of the world.

It can feel like the end of the world. The other thing that I think is important is that most recessions aren't actually that. When you look at recessions over the course of time, you have the tech bubble at the end of the two thousands, and that that burst that was there was certainly excess and overheating in the economy.

That created a pretty deep recession. The financial crisis in 2007 to from oh seven to oh nine created a pretty deep recession and then covid really short, but also really de recession. Those are actually not the normal recessions that we've seen. When you look back over the history of the US economy and over the global.

Typically what happens is the economy overheats a little bit and then you have the GDP growth decline maybe by half a percent or 1% for a couple of quarters, maybe for a year. And then you roll out of it and, and growth continues for a long period of time. And so we can talk more about that later in the episode.

But recessions don't have to be as bad, I think, as what we have experienced, you know, in in recent times. So are you concerned about a recession coming? Where's your head at?

I think it's highly likely a recession is, and I felt that way long, like for a while now. Even when we had the conversation, you and I had a conversation about how recessions require underlying issues. Mm-hmm. , I felt like the excess amount of cash in the market was an issue that would require like a right sizing or reconciliation.

I mean, I'm no expert, so people who are listening, I'm just a normal person. , but here's what I think. I think yes, we're gonna have a recession. It's not gonna be the worst recession that we've lived through, but it's gonna be a recession. And recessions always suck. They suck because people lose their jobs.

It's hard, like from an economic mobility perspective, it's hard. It just makes the world feel not very much fun. All the things. They're not easy, but I think on the flip side, I'm struggling. I was telling Brian, I'm struggling with recording this episode because I believe that our listeners now have enough lived experience to have lived through at least two recessions.

You've lived through at least the Covid and the oh 8 0 9 recession, and I think that that that lived experience gives you some perspective that recessions are not fun. They really do suck, and we've been through some doozies of recess. These last, you know, few times that we've had a recession, but they also don't last forever.

No, they don't. And you just kind of like suck it up. You hold your strategy and you wait it out. Like to me it's like a storm. Like what do you do when it rains? Like yeah, you stay home and you hold down the fort and you wait for it to stop freaking raining. Like that's what I feel like, that's what I feel like about the.

Yeah. Wait for it to stop raining. Well said. So I don't, I guess I'm like, I told, I don't, I'm struggling with what to say on this episode because I wanna believe that our listeners know this and maybe what they need to hear is that, a, get an umbrella, B, it will stop raining again. . Yeah. I think it's, it's the psychology that people struggle with and I think it's natural, right to do that.

There's just this temptation to, to sell or to, or to stay out. And, and like I said, I think there's a couple of things that, that are challenging about that. One is it's difficult to predict a recession. It's very possible that the economy is corrected without actually having negative G D P growth. These are things that we're hearing out in the world, in the news world, Brian.

what do you think is coming our way? So I think the, the first thing is it's important to know that economists are actually terrible at predicting recessions. They're actually worse than the weatherman. The weatherman is right about 80% of the time for a seven day forecast, which I think a lot of people say, no, there's no way.

That's true. That's actually true. When they tell you that there's a 30% chance of rain, it means that 70% of the time it's not going to rain. So based on the percentages, they're right about 80% of. , um, economists miss on recessions more than they hit, so they're right less than half the time. So I wouldn't, I wouldn't tie my investment strategy.

Something that's worse than recessions don't cause themselves. They're caused by either an overheating economy or by these exogenous shocks to the system after a long expansions. Inflation tends to rise as demand for goods outstrips the ability to produce goods in the economy. That seems a lot like what's happening today, which causes prices to rise, demand for workers to rise, wages rise, all of those things turn into an inflation, right?

And when inflation begins to rise above the Federal reserve's target, they raise interest rates to slow the economy down and control I. That usually causes a mild recession. So that's what happens when we have an overheating economy and the Fed essentially creates a recession to slow down inflation shocks to the system also cause recessions.

Good examples of those are the tech bubble in the late 1990s, the financial crisis in 2007, and of course Covid in 2020. Recessions caused by shocks to the system. They tend to be deeper and more painful than the more mild recessions that are induced. When the Fed just needs to cool things off of it, those fed induced recessions, we often see growth only, you know, maybe negative half of 1% or 1%, but then significantly more, three, four, 5% negative when there's a shock to the system.

So do we have the conditions for a recession today? I'd say absolutely. We have an overheating economy for sure. The Fed has said as much and they are raising interest rates to combat that. There's still almost two open jobs for every available worker. The Fed is increasing interest rates to slow the economy down.

Oil could potentially be a shock to the system, although I think the real shock case is lingering covid supply chain issues in the combination. That plus what's happening in the oil markets is potentially contributing to inflation. However, we have had overheating economies in the past that did not result in recessions.

So like I said earlier about predictions, it's really hard to say whether all of this will add up to an actual recession or not. In order for GDP to actually fall consumers, businesses, or the government, I can mention earlier, one of those components of GDP actually has to reduce what they're spending.

Consumer spending rose in April. That's the last data that we have, even on an inflation adjusted. Business investment continues to be strong. Government spending is flat down. Uh, year over year, the stimulus payments have worn off, and so obviously that reduces government spending. But in order for GDP to decline further from here, something has to go down and I'm not sure what that is.

Potentially inflation could cause in consumers to have to. Pair back their spending. So far we've seen that consumers are switching back to services like restaurants and concerts and travel, but they're not spending as much on sort of home goods categories and casual clothing, athleisure, all the stuff that people bought a ton of during the Covid pandemic, but they're still spending money.

And so unless this, the, this is known as like the end of athleisure and the home decorating recession, I'm not really sure what's going to slow down. So I don't see a recession as a foregone conclusion. It, it's just a, a possibility. But regardless of whether we actually have a recession or not, I think it is very safe to say that we're going to have a slowing economy.

And, and I think there's, there's really broad consensus about that. And I think from an investment stand, That's what should be top of mind for investors, not whether or not we're going to have a recession or not. I think the thing that is important is what do you do as an investor? Maybe we don't know for sure whether recession is coming, but what should we do?

And, and I think this is another place where folks can get into trouble, you know? Do you think the stock market goes up or down during the recession? I mean, this is wrong, but I think the stock market goes down initially, but it always comes back up higher than it was before. So I don't What is the right answer?

Yeah. Well I think, I think that's surprising for a lot of people. The stock market actually averages positive returns during recess. Not as high as it's hurdle. Returns are, are around three or 4% on average during, during recessions, certainly under the seven 8% that we're used to. That's especially true for more anemic recessions, you know, that are caused when the, when the Fed tries to slow down and overheating economy.

So when they say something like, during the crash in 2008 s and p lost 50% and regained all losses within two years. Mm-hmm. , how does that make sense? In light of what you just. . Um, so, so there are absolutely recessions where the stock market is down. It's just more often than not up during the actual recession, the.

The other thing that's important is the stock market is a discounting mechanism. In a lot of cases, the market peaks before a recession declines, sort of anticipating a potential recession bottoms out before the recovery starts and then starts going up again during the middle of the recession. And if you think about it, the best time to invest, you know, during the Covid recession was, was in um, April and May of, of 2020, right after all of the Covid news came out and we shut the economy down.

We were still in the middle of that recession, but the market bottom now, anticipating that we would. So it's not that the market doesn't drop, but the market is going to probably drop before we're actually in a recession. And, and you know, it's just another reason why trying to predict whether a recession is gonna come is challenging.

And then whether or not you should, you know, buy stocks or sell stocks or, or make investment decisions based on a recession can be really challenging. So what do you tell people who think this is a good time to buy? There's a couple things you should be doing. , um, as an investor. And the first one is to rebalance your portfolio back to your target long-term asset allocation or the mix of, of stocks and other assets that you own.

And certainly stock markets have been down this year. So if you think about rebalancing back to something that's been down, that probably means you're buying stocks, potentially selling commodities or other other things, um, have risen in value. Disciplinary rebalancing is actually a really effective way of buying low and selling high, and it's much.

Sort of effective than trying to forecast recessions in the stock market. So in summary for this episode, we talked a little bit about what a, a recession is, which is a reduction in GDP growth. It's very difficult to forecast recessions. Economists are not actually very good at forecasting recessions, and so therefore it's really difficult for us to make investment decisions.

Purely based on whether recession is coming or not. Also, the stock market doesn't necessarily go down during a recession. Sometimes it does, sometimes it doesn't. And, and that's for two reasons. First off, it could be cuz the economy is still in pretty good shape. And the second is the stock market's a discounting mechanism.

So it may go down before the recession and it certainly will start to climb before the recession's over. So making investment decisions purely based on. Can be a a challenging idea. And so what you should be thinking about is rebalancing your portfolio. We've had market decline so far this year, so think about buying the things that are down and getting back to your target asset allocation.

All right, well thanks for joining this episode and we will see you next time on the Six Figure Investor.

The commentary provided is for general audiences and educational purposes only. It should not be construed as investment, tax, or legal advice for your specific situation. That's why you should talk to a professional. Hello, past Performance of market Results is no assurance of future performance. All the information on the podcast has been obtained from sources.

We deem reliable as of the date of this recording, but it's not guaranteed.