The R Word
June 28, 2022 | BY YOUR PARTNERS AT EQUINUM WEALTH MANAGEMENT
Let’s not try to sugar-coat this; 2022 has been brutal from a financial standpoint. The stock market has officially entered into a bear market, inflation has been producing nasty headlines and interest rates have gone haywire.
Let’s explore what has been happening under the surface.
Emerging out of the Covid recession many aspects of the economy were out of whack. For starters, many were out of work, so the government footed the bill by paying enhanced unemployment programs on top of other stimulus and business borrowing programs.
Giving the people extra money and not being able to spend it on vacations and restaurants as they were all closed, meant that American families’ balance sheets improved. So, although there was this once-in-a-lifetime pandemic and financial disruption, savings rates actually went up.
Once we emerged from the pandemic, people were desperate to spend. Demand was extremely high. But broken-down supply chains meant that demand outpaced supply which in economic terms creates inflation.
All this extra cash in hands of the American public, along with very easy monetary conditions from the Federal Reserve, also created an asset-buying frenzy. The stock market, real estate market, cryptocurrencies along with other assets caught a huge bid. The S&P 500 rose 113% off the pandemic lows, houses all over the U.S. were selling for 20%+ above the asking price, and speculative assets like non-profitable growth companies and cryptocurrencies were up hundreds of percentage points in just a few months creating a bubble environment.
The inflation pressures, which started in earnest in the middle of 2021, has put the Federal Reserve on its heels. At the start, they kept on saying that the inflation spike is “transitory”. But as it turns out, it is way stickier than they anticipated.
This experiment of money printing is something we wrote about in May of 2021, and I guess the debate should be settled.
Being that the Federal Reserve’s dual mandate is maximum employment and stable prices, they needed to jump into overdrive and slow inflation. The core way they do it is by raising interest rates.
Slowing the economy by reducing the circulation of money in the economy is the chief outcome of raised rates. When this slowdown spreads through the nooks and crannies of the economy, spending slows, so demands drop. The hope is that prices should come down.
This plan can come along with collateral damage. The R-word. Okay, I’ll say it, a recession.
By slowing the economy, spending goes down, so income goes down, so rents fall, so foreclosures go up… You get the picture. The Fed may try to accomplish one thing by slowing the economy, but there may be a price to pay.
Fed Chair Powell was asked during a recent press conference if he believes that we will have a “soft landing”, he responded “softish”. That is admitting to a lot in Fed Speak.
There is a case to be made that this is not the worst thing. The stock market is already paying the piper as it is, why not complete the process? If we manage to avoid a near-term recession, we’d only be temporarily preventing the inevitable: Recessions are a normal and natural part of the economic cycle and the longer we go without one, the worse the imbalances will be when we get there.
50% of Nasdaq stocks are off 50% from their highs. Once we got to this point, why go back up to new highs only for a recession in 2024?
So, if the recession comes, how can you prepare for this?
For starters, keep your leverage low. Purchasing real estate and other assets on leverage works great when the economy is humming. But when rents fall, vacancies are up and business profits fall, being left holding the bag with all the debt can prove costly. As Warren Buffet famously said, “only when the tide goes out do you discover who’s been swimming naked.” It may be time to de-leverage and sell some higher-risk assets.
Diversification is as important as ever.
From a stock market perspective, it’s very difficult to try to time it right. Markets tend to bottom out before the actual recession is wreaking havoc on the economy. Take the covid drawdown for example; the market bottomed out way before daily deaths spiked. The wealth destruction happened mostly before the virus was spreading in the United States.
The same would be with other economic events. The market is a forward-looking mechanism. The selling for an anticipated recession could be long over once we are actually in one. Trying to time the in and out right is almost impossible.
From an employment perspective, be nimble and ready to do additional tasks to keep salaries up to current levels. Layoffs are a nasty part of a recession and those who bring massive value to a company are the last to be tampered with.
As gloomy as this sounds, it is also a huge opportunity. As Sir John Templeton said, “for those properly prepared, the bear market is not only a calamity but an opportunity”.
So, keep your emotions in check, try not to do anything drastic, it’s not the time to score style points, and don’t try to overthink things. And don’t hesitate to ask for help.