Recession by itself is a depressing topic.
But if we want to talk about recession, we have to cover
many Macroeconomic concepts.
But it is even more depressing subject
for many of us
If we understand what recession is
and why it is coming, it helps in
making right financial decisions.
So in this episode, we are going to cover the
recession topic in more detail.
Before recession, lets understand
the concept of "Business Cycle"
In an economy, the output of goods and services
grows and then it falls
The repetition of this growth and fall cycle is
what we are calling it as "Business Cycle"
There are 4 important phases in this business cycle.
Expansion - In this phase, the output of
good and services keep increasing.
When the output increases, the income and
job growth grows along with it.
This phase is the most favorable for us.
Peak - The growth in the expansion phase
reaches its peak in this phase.
Recession or Contraction
This is direct opposite of expansion.
In this phase, the production will decrease and so the sales,
the income and job growth will decrease as well.
This is the phase that puts our financial strength
and mental toughness to test.
Trough
This is the bottom of recession.
After this, economy starts receovering
and gets into expansion phase again.
This whole business cycle repeats again and again.
Change is the only constant in life is
again proved by this "Business Cycle".
Though recession comes now and then,
In long term, the business cycle most of the times
keeps expanding in upward slope than contracting.
So in this business cycle, how can we measure
the expansion and contraction?
We are using GDP for that.
GDP is Gross Domestic Product.
i.e. How much goods and services have been
produced by a country in a given quarter is measured
thru GDP.
There are 3 options to
include a manufactured product in GDP
Measure at Production.
Include the product in GDP immediately when it was manufactured
Or Measure at Consumption.
i.e. bring it into GDP account
when the product was purchased/consumed.
Or Measure as Income.
Include it in GDP when the product is sold as income.
In US, we are measuring at consumption.
i.e., a product gets included in GDP
only when it is purchased.
For example, when a car is manufactured by Ford
It does not get included in GDP immediately.
But it gets included when that car is
bought by a consumer.
There are 4 main components in GDP.
Business Investments
Government Spending
Consumer Spending
And Net Exports
The total of all these 4 components makes up the
GDP of a country.
Business Investments:
The investments done by private
companies to expand their business opportunities will
get included here.
If Ford builds a new manufacturing plant,
that will come under business investments.
Government Spending.
Public infrastructure spending like road
construction comes under this.
Consumer Spending.
Common man purchases like car,
bike, clothes - all will come
under this.
Net Exports.
A country's net difference of Exports - Imports
will come under this.
For US, it is always negative.
Because the Imports in US is greater than exports
During expansion period, GDP's growth
will be positive every quarter.
In US, on average, the GDP growth is
at 2-3%.
During recession this GDP growth turns negative.
That means, the goods and services produced
this quarter is less than the same quarter
last year.
Normally, if we see a negative growth
of GDP for 2 quarters continusouly
we are calling it as recession.
But in official definition, a significant reduction
in economic activity is what is called "Recession".
In US, the consumer spending is a
significant portion in GDP.
Around 70%.
If consumers slow down on purchasing new products,
that by itself will push the economy into recession.
In US, on average we get a recession
once in 7 years.
The last recession was in 2008.
After that, now in 2020 we are in
recession because of Corona Virus.
Every recession can continue from 6 months
to 2 years.
On average, a recession continues for 10 months.
If a recession continues for many years,
we are calling that as "Depression".
US has experienced depression
only once in its history.
The depresssion that was there from 1929 to 1939,
is what we are learning as "Great Depression"
in History.
So when a recession comes, Government
and Federeal Reserve will fight together
to bring the economy back on its foot.
Government will change its fiscal policy
to spend more money than normal to
revive the economy.
Like spending on newer road or
invest in defense. Government tries to
spend more than normal on economic activities like that.
There will be big job lossses
during recession times.
That makes consumers more nervous
and makes them reduce their spending even further.
That makes recession even worse.
So in order to increase the consumer's spending,
Government will hand over some cash through
economic stimulus to common people like us
to encourage spending.
Now as part of Corona Virus Stimulus package,
they are giving $1200 for
every individual.
This is under the hope that the
consumer spending will increase
from this extra cash in hand.
All private businesses will cut down
on any new investments.
Future prospects investments like
opening up new manufacturing plant or
any R&D work, all will be put on hold
by private businesses.
Because, during tough times like Recession,
they do not try out anything adventurous, but
like to play it safe.
So in order to boost the business investments,
Federal Reserve will change its monetary Policy
to reduce the Fed Funds Rate.
Now the Fed Funds rate in US is "0".
That means, private businesses can
borrow for cheaper interest rate.
Fed's hope is that low interest rate
will boost business investments and
by that the GDP growth decline can be stopped.
So when Government and Fed are fighting
the recession together, what can we do?
Staying Calm
Knowing that recession is a temporary one,
and it is just part of a business cycle,
we have to face it with calmness when it comes.
On average, we have to face it once in 7 years.
So it is better to be prepared to handle that.
Job Risk.
When the economy growth slows down,
the chance of us loosing a job is higher.
All businesses try to have
their employees as long as they can.
It is not their intention to fire.
But to survive tough times, they
have to make some tough decisions.
We might have to loose our job because of that.
We should not be broken down by that.
It is part of the business.
We are offering our service to a business for money.
If our service is not needed there any more, we
should look for a place who needs our service.
It is as simple as that.
When the economy recovers, many job
opportunities will open up for us.
This is the kind of situation where the "Emergency Funds"
mentioned in our "Financial Freedom" video comes handy.
Not making changes in Portfolio
During recession times, Our Portfolio
will be beaten down.
It is part of market cycle.
In 2008, S&P 500 Index went down by 50%
But it recovered completely
in the following year.
Now, because of "Corona Virus", index is
down by 36%. But, it has almost
recovered completely.
So, during a recession when the market downturn occurs,
ride it out calmly without making any drastic changes.
Taking no action with the thought of
"This shall pass as well" is the best approach.
This is easy to say, but bit difficult to follow practically.
Lets say that we have 50 Lakhs in our portfolio,
when the market goes down by 50%, we will be
sitting at a loss of 25 Lakhs from its peak.
It is bit difficult to take it psychologically.
But we have to be bold knowing
that it is part of the market cycle.
Any drastic action will end up hurting
our portfolio in long term.
Having right allocation in assets.
Because recession can hit us any time, we should not
be keeping our short term needs in share market.
The money that we do not need for at least
5 years is what should be invested in share market.
It is lot safer to invest the money needed for short term
in other safer assets.
Control the Expenses.
It is better to postpone any expenses
that is not an absolute need during recession times.
Is there a way to predict the recession
before it comes?
Not accurately.
But by tracking some of the macroeconomic
indicators, we can follow the current
health of the economy.
ISM Manufacturing Index.
This is also called as "Purchase Manager Index (PMI)".
This index measures the manufacturing activity.
If the value is above 50%, then it means, the production
is bigger this month compared to last month.
i.e. Economy has expanded.
If the value goes below 50%, then
it means the economy has contracted.
Its April month's value, as expected,
is below 50% at
41.5%.
Employment Report.
We can learn whether a job has expanded or
contracted by looking at the monthly
employment report.
For a healthy economy, we should see a
positive growth in job numbers every month.
From the lockdown due to corona virus,
the job report that released last week
has shown a job loss of 20.5 million jobs.
We have never seen this big of a job loss
since Great Depression.
During dire times like this, to check on the health of
the economy, we can check on weekly jobless claims data
as well.
Consumer Confidence Index.
Consumers mindset is measured
through a survey. This measurement is
published as an Index through
"Consumer Confidence Index"
As we already saw, consumer spending is
70% of the GDP.
So it is a key measure to understand the
consumers mind to follow the health of the economy.
If its value is above 100, then it means
consumers are feeling positive.
Its latest value as of now is 86.9.
When the job loss goes up, consumers
confidence keeps going down .
In coming days, this will down even further.
When the economy recovery starts, the value of
consumer confidence will start to go up.
To check on the health of the economy, just
checking on this basic economic data is good enough.
We don't have to be a big economist.
I hope this episode would have helped you to
understand recession better.
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