We see the dreaded "R" word reference "Recession" everywhere now.
Even if we are calm, media won't let us alone.
Is recession coming? Is it already here? They are scaring the heck out of us.
As if that is not enough, these youtubers have joined them as well.
Some have declared that we are already in recession.
Some others have suggested to sell everything and get out of the market as it is going to get worse.
So what is actually happening? We will dig into that in this episode.
Hi. My name is Vijay Mohan. You are watching Investment Insights.
We have already reviewed - what is recession and how a government handles a recession in "Recession Explained" episode.
If you have not watched that yet, please watch that first. It will help you follow this episode easily.
When there is a significant decline in the economic activity of a country, we call that as a recession.
When we look at quarter 1 GDP of US, we can see that it is still expanding.
That means, US' economy is still growing.
What? It is still growing? Then why is everyone scared about a recession?
To understand that, we have to take a closer look at everything that has happened since Corona.
We were pushed into lock down situation all over the world when we understood the seriousness of corona in March 2020.
Lockdown will lead to a block in economic activity resulting in low GDP and so a recession.
How can we fight that out? As we already saw in the recession episode, consumer spending and business investments are critical components of GDP.
If these two are stimulated to increase, we would be able to get out a recession.
So consumer spending - that is the everyday expense that you and me do.
What can we do to increase that?
"Let us give free money to people. They will have second thoughts in spending only if it is their hard earned money...
"But if it is a free money or if they have an illusion of free money, they will start spending without any hesitation"
That is exactly what US Government did. It gave 1000's in stimulus money to everyone.
We also spend the money as if there is no Tomorrow and brought up the consumer spending.
Next is Business Investments. How can we stimulate that?
"We will give loans for cheap interest rate. Everyone will rush to borrow and invest to take advantage of the low interest"
And so federal reserve brought down the fed funds rate to Zero.
They did not stop at that. They started buying bonds from open market.
You might ask, where did they get all this money from. Where else - all from printing.
Their intention is to increase the money in the market.
That should automatically stimulate the economy is their plan.
It worked. Though US GDP crashed down by 31% in 2020 Quarter 2, it came back up in the next quarter.
Very good. All seems good now. What is the problem now?
What happens when there is more money rotation in the market?
Money will lose its value. That will lead to price increase in our everyday purchases.
A $10 thing will now cost over $11. That is inflation.
For last 10 years, the inflation was at an average of around 2%. But now, it is at 8.3%.
Even though the actual GDP looks expanding, when we take inflation into account in real GDP, we can see that it has gone into negative territory. -1.4%.
The good thing is, consumer spending and business investments did not go down. They both went up.
But it is not good to anyone to leave the inflation growing uncontrolled.
What can we do to bring down the inflation? We have to cut down the money rotation in the market.
For that, interest rate needs to be increased. That is exactly what Federal Reserve did.
Fed funds rate was at 0% till February. It increased to 0.3% in April and now in May they are increasing 0.5% more.
So now the current fed funds rate is 0.83%.
Everyone is expecting this to go up in coming days.
We can expect this interest rate to go up till the inflation comes down from 8.3% to 2-3%.
But if we increase the interest rate like this, what happens to the economy?
Its growth will slow down. Because when interest rate goes up, business will hesitate to do new investments.
When new investments go down, that will slow down the job market.
That means, the job openings will go down.
If the job market slow down, that will bring down consumer confidence.
That means, people spending money like there is no Tomorrow will now be very careful with their spending.
What happens to GDP then? Business investments and Consumer spending are critical components of GDP.
If they both go down, that will bring down the GDP as well.
If the GDP goes down significantly on negative side, that will be the recession.
Are we in recession now? That is a difficult question.
Because, we will know that only when recession is over. It is difficult to know when it is happening.
So far, inflation has gone up. To fight that, federal reserve has increased the interest rate. That is all has happened so far.
As the interest rate is increasing at a faster rate than expected, all companies are expecting a slow down in the economy.
During their first quarter results announcement, they have cut down on this year's outlook.
That is, they are acknowledging that the revenue for this year is not going to be like they expected and so they have cut down on its outlook.
Job market looks strong so far. 428,000 jobs were added in the money of April.
As the companies have cut down on their outlook, that means they would not post new job openings easily.
There is a good chance for the job market to slow down in coming months.
Consumer spending is looking strong till now. But we can see that the consumer sentiment is getting weaker.
If the consumer sentiment is weak, that means people will tighten their wallets. They will hesitate to spend.
Retail sales will come down. We will see its impact in coming months.
We are seeing clues of economy slowdown like these everywhere.
As there is a good chance of recession, stock market indices - S&P 500 has gone down by 20% and Nasdaq 100 has gone down by 30%.
Specifically Technology sector has come down a lot. Because, when there is a cut in private investments, the first impacted department would be Technology.
That is why Technology sector is beaten down heavily.
Stock market always look at the future. If it sees immediate problems in short term for its growth, it will tend to go down. That is what is happening now.
Until the inflation comes under control, we can expect the market to be volatile like this.
Market will go up only when it sees that the chances of economy expansion is higher than the economy contraction.
No one can predict when that will happen. That is why we are saying that it is impossible to time the market.
What should we do during times like this? Nothing.
Accepting that it is part of business and economic cycle, we should not bother the investments and let it grow for long term.
This shall pass as well.
"No. I can easily identify the market bottom. So I am going to sell everything and sit outside for now.
"My guru has recommended that as well" - if you are in that camp, that is your choice. I cannot say anything about that.
We will soon meet again in another episode. Thank You!