If you’ve been following the U.S. stock market and listening to the news for the last week or two, you might be under the impression that the world is coming to an end.  “The Dow Loses 12% in 5 Days!”  “Coronavirus Infections Confirmed In 58 Countries!”  “Tom Brady Unlikely To Return To The Patriots Next Season!”  Truly, this news could leave you with your head spinning and wondering about whether the next recession is upon us (or at least whether to draft Brady for your fantasy team).

Indeed, the Coronavirus is no joke and should be treated as any other bad outbreak of the flu or other infectious disease.  DO wash your hands with soapy hot water several times per day; DO cover your nose and mouth when you sneeze or cough; DO take extra precautions when going to a public place, especially if you are more vulnerable to disease; DO avoid unnecessary travel to countries or regions with a significant outbreak; DO call your doctor if you have severe or prolonged flu symptoms.  DON’T touch your eyes/nose/mouth, especially if you encounter someone with flu symptoms; DON’T wear a mask if you’re not sick; DON’T go to work or public places if you have a fever or symptoms; DON’T panic.  This last one, of course, is particularly important, since this is neither the first corona virus, nor the most severe flu outbreak, in the last century.

Returning to the idea of the next recession (this isn’t a public health blog, as thrilling as that sounds), it has been widely reported that last week’s stock market woes were caused by fear that the virus would be more widespread and sustained than originally expected.  However, although the Coronavirus certainly may have been a “trigger” of a sell-off (an economic term for “the straw that broke the camel’s back”), it is true that certain fundamentals of the economy have been weak for the last year or two.

1) Corporate debt is at an all-time high.  We’ve seen a few major bankruptcies for household-name businesses like Payless ShoeSource, Forever 21, and Sears/Kmart all due to crippling debt.

2) Consumer debt is reaching new highs in certain categories. Student loans debt has doubled since 2010, all while wage growth for those repaying the loans has gone up only marginally.  Auto loan delinquencies have now reached a 19-year-high, especially in the atrocious 7-year loan category, and are now at levels that exceed the Great Recession.

3) The global political climate has grown more uncertain.  Issues like Brexit, instability with Iran, and tariff wars with China create instability that makes investors panic and negatively impact the U.S. and the global economy.

4) The yield curve inverted in 2019.  This means that short-term interest rates are larger than long-term interest rates, which means that investors see more uncertainty in the near future.  Experts say this has happened prior to each of the last seven recessions.  NOTE: The curve inverted, then “un-inverted,” and may be re-inverting again.  Stay tuned.

5) Income inequality has increased.  The rich have gotten much richer and the poor stayed about the same… or, at best, have gotten just a little bit less poor.  Income inequality is sometimes considered a precursor to a recession because it means that a financial disruption among relatively fewer people can have a more significant economic impact.  To understand this at a smaller level, imagine you have a family of ten.  If you have just one working adult who then loses their job, the entire family is in trouble.  If, however, you have two, three, or more working adults, then one losing their job doesn’t have the same impact, even if the total family income is the same.

6) The economy might be “due” for a recession.  On average, there has been a recession every 7 years for the last 100+ years.  Sometimes the economy grows for just 2-3 years before a recession; sometimes it grows for 9-10.  The fact that the U.S. has been growing for 12 years and not seen a recession since 2008 is unprecedented.  Economists expected (hoped) that because the Great Recession was so bad, it would be followed by a period of longer-than average growth.  It has, but I don’t think anyone would have expected 12 years of steady growth is most areas.

For any readers unfamiliar with the word “recession,” the term basically means a decline in economic activity in a given area, such as the United States.  Many governments define a recession as two or more consecutive quarters of declining gross domestic product (GDP). Another way of saying this is that a recession six months where the economy isn’t growing.  In practice, recessions often include (a) increases in unemployment, (b) involuntary declines in personal spending, (c) lower production for businesses, in the form of lower sales growth and/or profits, and (d) a loss in consumer and corporate confidence.

Recessions are bad, but they are also very normal.  As the economy grows (“expansion”), consumers and businesses make more money.  As they make more money, they spend more money and take on more debt.  This spending and debt cause prices and wages to rise (“inflation”), often at a faster rate than the underlying growth.  Eventually, this process reaches a peak, and people are no longer able to afford as many goods and services they were before.  As a result, the economy begins to shrink (“recession”), and consumers and businesses make less money and default on their debt.  This set-back causes prices and wages to fall (“deflation”), again, often at a faster rate than the underlying economic decline.  Eventually, the process reaches a trough and starts over again, once prices have fallen low enough for people to afford things again.

The expansion and recession process is partially self-correcting, though governments may intervene to assist the process along.  When the economy is good, they may raise interest rates in an effort to prevent inflation from getting too high.  When the economy is poor, they may lower interest rates to encourage spending.  Governments “should” generate surpluses during strong times and spend these surpluses in the form of stimuli during weak times… though the reality is that politicians historically have spent more than they’ve taken in all the time.  Perhaps we can learn from their mistakes!

As you can see, the overall average slowly increases over time.  This is a good thing.  It’s just a shame it tends to take on a roller-coaster-like pattern in the process.  The world is not coming to an end.

Do I personally think a recession is coming though?

Well, yes.  I think a recession is likely within the next year or so, if it’s not already here.  The economy has grown very well for the last 12 years.  The stock market has recovered rapidly; unemployment has been extremely low; consumer confidence has been high for a long time; and businesses have been highly productive for over a decade.  This implies (to me) that we are at or near a peak, and a downward correction is probable. 

Unfortunately, I’m fresh out of crystal balls, so predicting the exact timing of the recession is anyone’s guess.  On the one hand, the 6 factors I listed above are real concerns and could collectively trigger the next recession, even though none of them would on their own.  On the other hand, because our growth has been slow and steady and because unemployment and inflation have remained low, it makes sense for our current period of growth to continue.  However, I also think that the next recession won’t be as bad thanks to what we learned from the last one.  We haven’t even seen a downturn for one quarter, much less two, so in the words of Yoda:

What does this all mean to us?

As consumers and everyday people, there are some takeaways from this.  Recessions are normal but unpredictable, so there are some steps you can take to position yourself when one does come:

• The single best thing you can do is to remain prepared for a recession but not let the fear of it take over your life. 

• Prepare by making sure you have an emergency fund of 3-6 months of your core necessary spending (it isn’t a coincidence that most recessions last about 6 months).  If 3-6 months isn’t realistic, it’s even more important to start, say, with one month.  Doing so could save you from going into debt immediately if you were to lose your job.

• Cut back on non-essential spending, and pay down your debt aggressively. 

• Come up with a plan if you or your partner were to lose their job for a period of time and what the impact would be on your family financially and emotionally.  Be sure to consider even the worst-case scenarios of needing to find new housing. 

• Make sure you are insured against things that could have a major impact on you financially, like your health or home. 

• Consider reducing any riskier investments you have for some more conservative ones, and don’t take on any major new risks that you can’t afford to lose. 

• Ensure you have some cash or liquid assets to cover any transitions you need to make during a recession, like finding a new job or moving to a less expensive area. 

• Begin the process of diversifying your income sources with a side gig.  Start with a few ideas here.  Apps and websites nowadays let you sell any of your skills, whether its driving, cleaning, tutoring, or playing dungeons and dragons!

• Assess your current work situation with your employer if you can.  Some employers are more open to discussing the company’s future with their employees.  You may also be able to tell whether things appear to be slowing down a bit too much.

• Keep learning new skills and make your services valuable in the workplace.  The least productive employees relative to their salaries are often the first let go.  If you can make yourself invaluable to your employer, you’ll better be able to weather the storm.  Keep mastering hard things and taking on tasks that others shy away from.

Should you be worried about all this?

No.  In fact, the most important thing is to stay calm to avoid giving room for fear to drive your decisions instead or rational thinking.  Remain calm, work hard, keep saving, and find peace in knowing that any economic downturns will be temporary.  Don’t try to time the market or alter your long-term goals. Definitely don’t stop contributing to your retirement fund. 

The stock market may have lost 12% last week, but this is because the market wildly overreacts to current events.  The fundamental economy is not 12% weaker, just like it was not 30% stronger at the end of 2019.  Just because the market and news react far too strongly to current events does not mean that you should.  Be prepared for the worst in the short-term, but expect the best in the long-term.

Here’s some data to back this up.  One of my favorite financial YouTube channels, Next Level Life, did a fantastic analysis on what happens immediately after a day where the stock market loses 3% or more in one day.  We had several of these last week, and there have been over 300 since the 1920’s.

The left column tells us that after a major day of losses (sometimes called a “Black Swan Event” because of their extremely low probability), the stock market will, on average, regain 0.41% within one week, will be completely recovered within one quarter, and will gain 9.2% within one year (more than 3x the amount lost)!  Sure, there are some extremes in both directions – as shown by the Min and Max columns – but a single even like we had last week is not enough to predict a recession.

The coronavirus may indeed be one of these Black Swan Events and may cause global productivity to dip a bit.  If it is prolonged or particularly severe, it may cause the economy to contract because consumers and businesses will cut back their spending and investment.  Then again, it may be just a temporary hiccup and the market could return to normal in no time.

For some perspective, here are a some of the largest single-day losses in stock market history.  Some were followed by periods of significant market downturn (Great Depression, Great Recession); some were followed by periods of market upturn (the Mini-Crash of 1997).  The coronavirus drop of 4% last Thursday doesn’t even crack the top 25 single-day market drops in the last 100 years.  True, we’re only looking at single days here rather than weeks or months, but last week was far from the worst in history.

The point is, nobody can predict the market.  Those that try often end up buying high and selling low, the opposite of what you should do.  Unless you get improbably lucky, you will always be financially better off by buying and holding for long periods of time rather than trying to predict every turn of the market.  The old saying remains true:

“Time in the market beats timing the market”

What you and should control, however, is your level of preparedness for significant events.  You can control your non-essential spending, your taking reasonable precautions for your health, your commitment to an emergency fund, and your willingness to continuously improve your professional skills.  These things are recession-proof.

Remember, recessions hurt the most for those who are unprepared.  If you can weather the storm without acquiring debt, you could come out on the other side in a great position.  If you do acquire debt out of necessity, remember, you can and will pay it off.  After a recession, stock prices are low, home prices are low, and opportunity for new investment is high.  However, if you can’t manage your finances now, the recession will likely set you back for a while, with fewer opportunities on the other side.