Disclaimer

I am not a financial adviser and this is not financial advice, I’m simply sharing my personal opinion and thoughts.

Intro

Let me kick things off by making it clear that my intention with this article is not to scaremonger, I’m aware that recessions aren’t something to be taken lightly – hence why I’m actively preparing for the next one.

Back in 2017, I began researching macroeconomic trends as I thought that it could give me an edge within my long term investing strategy.

Upon digging deeper and developing an understanding of economic cycles it became clear that recessions are inevitable and predictable.

While researching I started seeing the signals that the next recession may be imminent, this drove me to take a hard look at my vulnerabilities and begin putting together a defensive strategy.

In this article, I’ll explain how I’m preparing and I’ll also run you through the warning signs that the next recession phase may be near.

 

Let’s begin.

What Are Recessions & Economic Cycles?

What is a Recession?

Let’s start by defining what a recession actually is; The technical definition of a recession is two consecutive quarters of negative economic growth as measured by GDP (1).

“Recession” is almost seen as a bad word however it’s unnatural for any economy to eternally grow without declining. Just as the stock markets have bull markets and bear markets, the economy also has periods of growth followed by periods of decline and vice versa.

Recessions are just one of the four phases within an economic cycle (I’ll go into more detail on this later)

Recession Case Study: The Global Financial Crisis of 2008

To deepen our understanding of recessions let’s take a closer look at the world’s last global recession phase; The great recession of 2008, which is often considered as the most serious financial crisis since the great depression of the 1930s.

In 2007 the irrational exuberance in the US housing market led many people to buy houses when they couldn’t afford the loan repayments. Everyone thought that house prices could only go up. Investors took advantage of the low interest rates in 2004 and 2005 by buying houses just to resell. Others bought houses they couldn’t afford thanks to new sub-prime mortgages which were granted to people with low credit ratings.  These subprimes were also converted into securities which were traded on financial markets.

Due to the low lending requirements, nearly six million, mostly low-income US households received these sub-prime loans. which drove up the price of houses. However, these forms of mortgages had higher than average interest rates.

People couldn’t keep up with their high-interest mortgage payments which caused huge amounts of borrowers to begin defaulting.

This meant that their houses were put back on the market but by this point, there weren’t enough buyers. Due to the increased supply but low demand house prices began to crash.

In 2006, the bubble burst as housing prices started to decline. This caught many homeowners off guard who had bought home while putting very little down as a deposit. As they realised that they would lose money by selling the house for less than their mortgage they foreclosed.

 

These bad sub-prime loans caused some huge lenders to declare bankruptcy and the problems also rippled into huge insurance companies who developed financial instruments based on sub-prime mortgages such as AIG.

Panic set in, the credit markets froze and the US stock market crashed.

Because of the way global finance was intertwined, securities linked to subprime loans were accumulated in all the banks on all the financial markets around the world which led to the bankruptcy of banks outside of the US such as the British bank Northern Rock.

Government intervention did not stop the financial crisis from affecting the economy. Cascading bank failures led to a credit shortage, which blocked investment and corporate operations, plunging the world into a deep economic recession – the first to touch so many countries simultaneously. (2)

After the global crash and recession, the global economy then went into the recovery phase and then another expansion which has led to us surpassing the pre-2008 crash levels and today we’re sitting at new all time highs. This whole pattern has repeated itself many times and is known as an economic cycle.

What is an Economic Cycle?

An economic cycle is the downward and upward movement of GDP around it’s long term growth trend. The length of a cycle is the period of time containing a single boom and a contraction sequence however the average length of the last eleven cycles between 1945 & 2009 has been roughly 6 years each.

Each cycle has four phases, they are: expansion, peak, recession and recovery:

Expansion: An expansion comes before the peak. That’s when the economy is growing and GDP is increasing. The GDP growth rate is in the healthy, unemployment rates are low & the stock market is in a bull market.

Peak: The growth in the expansion phase eventually slows down and reaches its peak. During this phase the growth rate hits it’s maximum limit which leads to gradual decrease.

Recession: Economic growth weakens. GDP growth falls for multiple quarters (This is what defines a recession). Mass layoffs make headline news, the unemployment rate begins to rise and businesses wait to hire new workers until they are sure the recession is over. Stocks enter a bear market as investors sell.

Recovery: During the recession phase the economy touches it’s lowest level and bottoms out, things then start to move upwards again which leads to the recovery phase. This leads to positive attitude towards various economic factors such as investment, employment and production.

We then move back into the expansion phase and the next cycle continues.

5 Signs That the Next Recession Period Is Near

There’s a famous quote which is often attributed to Mark Twain which is “History doesn’t repeat itself, but it does rhyme”. This quote is often referenced to within predictive theories as we, as humans tend to make the same mistakes over and over again.

While the details of market cycles and recessions (Their timing and amplitude) differ from one to the next, there are certain themes which prove relevant in cycle after cycle. The points I’ve outlined below suggest that the current expansion/peak phase could be coming to an end and that soon we may head into the recession phase within the next 3 years.

1: Many Global Stock Markets Are at Their All Time Highs

Below is the chart of the S&P 500 over the last 50 years. The S&P is a good gauge of how the US stock market is performing as it’s based on the market capitalisations of the 500 largest U.S publicly traded companies.

The S&P has been on a bull run since 2012 and may be reaching its peak, The UK equivalent, which is known as the FTSE 100 is also close to an all-time high range. The NIKKEI 225 (Japan), DAX (Germany) & NASDAQ 100 (US) are all floating around all-time highs too.

If you’re reading this blog on a mobile and you can’t read the charts, try turning your phone on it’s side or open the image in a new tab to zoom in 🙂

Similar to the economy, it’s unnatural for the stock markets to eternally grow without declining. Cycles exist within the stock markets, similar to the economic cycles we discussed earlier.

Once the markets begin to decline this momentum could cause the next stock market crash.

Stock market crashes can easily kick start recessions, the underlying reason for this is that stocks are shares of ownership in a corporation. As a result. the stock market reflects investors’ confidence in the future earnings of all the companies in it. Corporate earnings are dependant on the health of the economy. That makes the stock market a leading economic indicator for the economy itself (3).

A crash signals a massive loss of confidence in the economy. when the confidence is not restored it leads to a recession. Declining stock values mean less wealth for investors. A crash also frightens consumers into buying less which decreases GDP.

2: Global Debt Is at an All-Time High

The last two recessions started with the popping of an asset bubble, In 2001 it was dot-com stocks and in 2008 it was houses and the mortgage securities backed by them as we discussed previously. This means debt bubbles can be a leading indicator of recessions.

The current global debt has surpassed the levels before the 2008 crash and is now sitting at an al time high of $184 trillion according to the IMF (4)

Corporations have loaded up on debt over the last decade spurred by low interest rates and the opportunity to increase returns for shareholders.

In many areas of the world, consumer debt is also at an all-time high.

UK:

Household debt in the UK has hit a fresh high of £428 billion according to an analysis by the TUC.

The TUC arrived at its figure for unsecured debt by adding up the total amount owed in bank overdrafts, personal loans, store cards, payday loans, credit card debts and student loans.

Excluding mortgages, the average debt per household rose sharply in 2018 to a new peak of £15,385.

Millions of households are now reliant on borrowing to get by, with working families on average worse off than before the last financial crisis. (5)

US:

Americans are also diving deeper and deeper into the red. As of February 2019 outstanding consumer debt exceeded $4 trillion for the first time.

Total credit card debt is also at its highest point ever, surpassing $1 trillion. At the same time, credit card interest rates have never been higher. The average card interest rate is currently 17.41%. (6)

 

3: The Average Length of Economic Cycles

As mentioned earlier, economic cycles tend to last every 6 years. Below is a chart of Gross Domestic Product growth over the past 45 years.

The last global recession which we covered in the previous chapter was the 2008 recession (The great recession). This was over 10 years ago now and countries such as the United States are celebrating their 10th year of expansion which is the longest on record.

When you look at the average length of an economic cycle and the average period between previous cycles it’s clear to see that the next recession may be overdue.

4: The Yield Curve Has Inverted

On December 3, 2018, the Treasury yield curve inverted for the first time since the previous recession. 

An inverted yield curve is when the yields on bonds with a shorter duration are higher than the yields on bonds that have a longer duration. It’s an abnormal signal which has often occurred shortly before past recessions. When a yield curve inverts, it’s because investors have little confidence in the near-term economy. They demand more yield for a short-term investment than for a long-term one. (7)

The Treasury yield curve inverted before the recessions of 2001, 1991, and 1981. The yield curve also predicted the 2008 financial crisis two years earlier when the inversion occurred on December 22, 2005. 

“The Treasury yield curve inverted before the recessions of 2001, 1991, and 1981.”

5. Unemployment Is at an All Time Low

Low unemployment rate and a strong job market may seem like positive economic indicators, however the unemployment rate is often one of the most important barometers of a coming recession. 

The reason for this is that low unemployment rate is often associated with a boom phase just before a recession. Historically, unemployment under 5% is quite rare and typically occurs after a long, powerful economic expansion. By the time the unemployment rate is under 5%, the economic cycle is already mature and nearing the next recession phase.

5 Strategies I'm Using to Prepare for the Recession

After researching economic cycles and the inevitability of recessions I immediately began looking at my options.

Initially, I considered abandoning civilisation, going off the grid and fleeing from the many constraints of mankind such as it’s monetary systems and clothing requirements.

However, after some careful consideration, I decided to look at which lifestyle changes and financial adjustments I could make to become more resilient against the effects of economic downturns instead.

Below are some of the strategies which I’ve been implementing since 2017 and will continue to implement and maintain over the coming years.

Reminder – I am not a financial adviser, I’m simply explaining my personal strategies. If you need advice regarding your finances then you should consult a professional.

1: Pay off short term debt

A bit of debt can’t hurt right? This is the question every person asks themselves when they first get a credit card and make a few small purchases, but before they know it they are thousands of pounds/dollars in debt.

What many people forget is that using credit is like borrowing money from your future self to satisfy the needs of your present self, then paying more for that purchase due to interest.

Part of the allure of credit is the fact that you can get the emotional high from getting new things now, without having to deal with the pain of parting with the money right now, in some cases it even feels like you’re getting something for nothing. But eventually your future self will need to deal with the consequences and it won’t feel so good.

Paying off short term debt will relieve financial strains and put you in a better position if you are impacted by a recession. One well-known method people use to pay off debt fast is the ‘Snowball Method’

The Debt Snowball Method

The debt snowball method is a debt reduction strategy in which you pay off debts in order of smallest to largest, regardless of interest rate. It works like this:

Step 1: List your debts from smallest to largest (regardless of interest rate)
Step 2: Make minimum payments on all your debts except the smallest.
Step 3: Pay as much as possible on your smallest debt.
Step 4: Repeat until each debt is paid in full.

The theory behind this is that once you start paying off some of your smaller debts in full, the positive feeling from that will help you build momentum so that you’re ready to then take on the bigger ones (similar to a small snowball rolling down a hill gathering size & momentum).

2: Build an Emergency Fund

During times of economic uncertainty, one of the common fears is redundancy & cutbacks. The reason for this is that during recessions many businesses slow down in the growth or drop in turnover which often results in the need to cut back on staff.

One way to reduce fear of losing your job and to be in a better position if it does happen is to have an emergency fund saved in liquid low-risk assets or cash.

How much do you need in your emergency fund? 3-6 months worth of your monthly income/salary is recommended.

Knowing that you can ‘survive’ for X amount of months without any income will take the pressure off massively in the event that you lose your job or source of income. 

It will also come in handy if you have other emergencies, I recently dipped into my own emergency fund when I had my luggage stolen in Spain which included my primary laptop. (My insurance wouldn’t pay out based on a technicality so I had to take the hit). I was able to order a replacement laptop on next day delivery to get back up and running quickly which made the situation slightly less painful.

3: Increase Earning Power & Reduce Living Costs

First take a look at your monthly earnings and consider how you can increase this. It may mean asking for a raise, working overtime if you’re employed. In my case, it means growing my marketing agency by securing new clients and making profitable investments & trades within my portfolio.

Next, take a look at your bank statements from the past 3-6 months and break down your transactions to see whether there are any opportunities to cut back on spending.

Some common areas to overspend are:

  • Food
  • Drink
  • Subscription Services
  • Clothing

Every additional bit of cash you make or save can be potentially used to clear debt, build your emergency fund or invest. Making decisions like this can quickly compound over days/weeks/months/years and make the difference between struggling to get by and thriving long term.

One tool that can help with managing spend is a budget, to grab a template of the budget spreadsheet that i use click here.

4: Diversification

Over the past few years, I’ve learnt first hand the importance of diversification and how having all your eggs in one basket can leave you hugely exposed.

The two main areas in which I utilise diversification are:

Diversification of Income:

Essentially this means having multiple sources of income, if you have multiple sources of income the blow will be softened should one of them take a hit or stop altogether.

For example, if you’re employed but have an additional part time job, if you lose your primary job – knowing you still have a form of income can reduce the blow massively.

Diversification of assets:

Once your debts are clear and your savings are secured it’s wise to then ‘put your money to work’ and diversify it into separate assets and investments of varying risk in order to build a stable portfolio.

Last year I felt the pain of over-leveraging and under diversifying when I allowed a chunk of my wealth to sit in a tiny cap Asian tech company which bombed by 70% – I sold the stock off, cut my losses and put it down as a lesson in the importance of diversification and risk management. (The stock has since dropped even lower)

During times of economic turmoil, people flee from equities into to “Safe Haven” assets such as gold or Cash (Aka Fiat).

Personally I’ll be hedging between cash and Bitcoin, as Bitcoin is a non-correlated asset.

I’m also using Bitcoin as a hedge against inflation and traditional financial systems, I plan on writing a full article about why I’m bullish on Bitcoin later this year. (Current price of Bitcoin at 29/07/2019: $9800)

Building a portfolio can be a complicated task so it’s recommended that one should seek the guidance of a qualified financial advisor for this.

5: Invest In Yourself

Write, read, research, experiment, try new things, put yourself out of your comfort zone, develop new contacts, take classes, gain new experiences and do anything which will help you develop your skills and stimulate personal growth.

Not only will this help you make progress within your current job/income but you will also be in a stronger position if you lose your job or income due to the recession or for any other reason.

Investing in skills which help with your career is highly beneficial but by “invest in yourself” I also mean invest in your health.

If you think that dropping some body fat would improve your health then click here to read how I did it.

Everyone should prioritise in investing in their own physical and mental health as your overall health is your number one asset in life.

Recommended Tools

The two main tools I’d recommend relating to this article are the book I read which helped me gain insight into market cycles and my budget spreadsheet which helps me monitor and control my spending: 

Mastering the Market Cycle –  Howard Marks

My Budget Spreadsheet

Conclusion & Action Points

The bottom line to this is that recessions aren’t much fun, but the more you prepare the easier they can be to cope with. For some people that are prepared, recessions can offer opportunities to buy assets such as property or stock at low prices while the majority are panicking and selling.

I hope I’ve provided you with some insights into recessions and market cycles and by laying out the ways in which I’m preparing I hope you may have some thoughts on how you can improve or build your own recession defence strategy.

If the thought of an impending recession is causing any form of anxiety or apprehension then take a breather and don’t panic:

Recessions are just part of a phase within economic cycles, there have been roughly 8 in the last 100 years. You have time to prepare, some minor lifestyle changes now can put you in a better financial position within 6 months to a year – all you need to do is spend less and save more.

  • If you would like to pick my brains on any of this please feel free to drop me an email on Elliott@oshoko.co.uk.
  • If you found this blog helpful then please leave a comment at the bottom of this page to let me know.
  • If you would like to read more content like this, click here to subscribe to the blog.

 

Thanks for reading!

References

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