What To Do Before The Next Recession

If you’ve tuned into the news lately, you’ve undoubtedly heard whispers about the U.S. economy headed for recession. You may have also heard that it’s probably NOT headed for recession. You may have heard that leading indicators are sending confusing messages about the health of the economy and what we might expect to see in the coming months. It might be boring, but some things never go out of style: proactivity and preparation. Since none of us have a crystal ball, and even if we did, it would probably only be useful as a paper weight, instead of spending our time on the hamster wheel of speculation, we could turn our attention to actionable steps that we can take right now to help us prepare to capitalize on opportunities that are presented during a recession.

Before we get started, let’s agree that the definition of a recession is two consecutive quarters of negative GDP growth. We’ve seen 19 recessions in U.S. history, from the Panic of 1797 caused by land speculation to a giant recession in 1873 caused by excess speculation in the U.S. railway system to the great Recession of 2008 (also likely caused by excess valuations). Recessions happen as part of the normal economic cycle, and so far, no two have been identical, but there are some considerable commonalities. What follows are some observations.

Point One: Recessions Are Part of An Open Economy. First, we have an issue of semantics. We need to change the question ‘What if we have a recession?’ to a statement, ‘What to do when we have a recession.’ Open economies (not run by the central government) follow a four-part business cycle:

• Trough, at the bottom of economic activity, followed by

• Expansion, where the economy grows at a rapid rate, followed by

• Peak, followed by

Recession, or contraction back to a trough

This cycle is an essential feature of an open economy. The question is not ‘if?’ but ‘when?’

Point Two: The Fed Usually Raises Rates Before a Recession. The Fed’s existence and purpose is two-fold; it has a Dual Mandate: “to foster economic conditions that achieve both stable prices and maximum sustainable employment”. Achieving stable prices means controlling inflation. In the Fed’s toolkit, raising interest rates is a tool to help rein in inflation. In eleven out of the twelve recessions since WWII, the Fed began raising rates before the onset of the recession. Only in the Pandemic-induced 2020 recession did this not happen.

There have been about two modern ‘soft landings,’ where the Fed raised rates, and later let off the gas to honor its mandate without a recession:

Inevitably, rising rates will reign in inflation, and also in the process, typically shrink the economy with a corresponding recession.

Point Three: What Happens during a Recession. There are some characteristics of post-WWII recessions that are fairly consistent:

· Recessions are usually preceded by, or commensurate with, a stock market decline. If we do not consider the 2020 recession (the exception) which included a meteoric fall and corresponding rise caused by the pandemic, we can see that each of the prior 11 recessions had a stock market decline, averaging -30%:

· Recessions are accompanied by a reduction in economic activity, notably Capital Expenditures (CAPEX) by businesses. Companies cut back on expansion to survive.

· Recessions are usually accompanied by an increase in unemployment. Companies cut back on employees to save cost.

· Research and Development and Technology spend tends to slow down.

· Interest rates tend to fall short term.

What To Do Before a Recession. What are some actions to take now to help you find opportunities in a recession?

1. Do a gut-check
2. Lean up
3. Have dry powder
4. Check borrowing
5. Consider waiting on large purchases
6. Investing: go shopping
7. Sharpen your skills and build your network

Do a gut-check. Analyze your full financial picture: Assets and liabilities, income and expenses. The time to review, or create and execute a financial plan is now. Orphan assets? Investment mix out of balance? All legal documents in order? Insurances shopped and tailored to your circumstances? If we have a slowdown, you want to focus on things other than trying to save on your car insurance. Check on these items now.

Lean up. Create a budget now. Account for three possible scenarios, which we can call the ‘Clint Eastwood’ approach: the Good, the Bad and the Ugly. How does cash flow look if everything stays the same? (The ‘Good). What if cash flow declines by 20-25% (The Bad). 40% (The Ugly). Work through all three scenarios with your family unit.

Have dry powder. Recessions create bargains. They might be stocks, real estate, or simple consumer goods. It could present itself as a business opportunity or equipment. Many of us could say ‘I wish I bought “x” back in 2009.’ Try to build up some cash reserves now.

Check borrowing. Credit tightens in recessions. Check your credit score now. Make any needed fixes. Line up your home equity lines of credit now. Banks are less likely to lend in a recession, so ready yourself before, maybe even borrowing now and holding the proceeds in a safe place.

Consider waiting on large purchases. As noted above, recessions create bargains. Holding off on a large purchase will have two effects: saving cash and potentially positioning you for a better deal later.

Investing: go shopping. As we noted above, every post WWII recession has had a corresponding stock market decline. What is interesting is that the declines usually start before the recession. Look for quality companies in essential businesses. You want the survivors, so look for the best.

Sharpen your skill saw. This is important irrespective of recessions. Companies tend to lay off employees in a recession, do what you can to ensure it’s not you. What skills can you add? What makes you more marketable? Who should you network with? How do you become more valuable?

Bottom Line: Recessions are part of the economy; one of the best things you can do is accept that, and be proactive about doing what you can to be prepare. All of the ideas above are solid advice in any kind of economy, but especially in, and before, a recession. Having a budget, improving skill, or crafting a financial plan are good ideas, in good times and bad. As always, I’ll try to answer questions. My e-mail is llabrecque@sequoia-financial.com.