The year 2020 has graced us with a great deal of uncertainty in terms of politics, geopolitical events, policy amendments, market manipulation, the trade war and the next global recession. The global financial crisis of 2008 drastically impacted the lives of ordinary people to a point where the thought of the next recession ignites fear, and for your information fear sells!
You will always hear economists telling people to “tighten their belts”, that’s because the economy is cyclical so a recession is inevitable. It is important to understand that a recession is negative growth for two consecutive quarters and a depression is a recession that lasts for two years where the Gross Domestic Product (GDP) declines by 10%.
A recession can be caused by fake money (or rather fake success) where people, businesses and countries have excessive credit that they are unable to repay. It can also be caused by market manipulation (such as quantitative easing gone wrong), geopolitical events, wars, assassinations, and even conflict of foreign trade (such as the trade war). The most significant causes of a recession are bubbles, where people become too optimistic about the future and tend to lack rationality as they overestimate their abilities.
One of the most important indicators of a recession is an inverted yield curve as it has been reliable in predicting previous recessions. The slope of the yield curve gives us an idea of future interest rate (yield) changes and economic activity, i.e. whether investors are putting their money in longer-term bonds or shot-term bonds. Short-term bonds tend to reflect government’s current monetary policy stance, while longer-term bonds tend to reflect market expectations of future inflation and the resulting path of interest rates. In times of uncertainty most long-term bonds have lower yields than short-term ones hence the slope of the yield curve inverts.
Now that you understand what a recession is, what causes it and how it can be detected, it’s vital to know how to hedge it. The following are tips on preparing for the next recession:
- Risk Tolerance: Your age and financial ability determines the amount of risk you can handle, so always be cognizant of your risk appetite.
- Hold some cash: Recessions present fruitful opportunities where people can buy assets at lower prices; therefore it makes sense to have cash available to seize those investment opportunities.
- Cash in some of your profits: If you have been holding profitable assets for a while, it can be advantageous to shed some of them off so that you can hold more cash or diversify in other more stable investments.
- Avoid new long term liabilities: In times of uncertainty, you can never be certain whether you will be able to meet your obligations as you might lose your job abruptly or your investments may go south.
- Protect your career: Become an expert in what you do. When the market crashes amateurs are exploited and experts become heroes, therefore work on your craft and become exceptionally good that you’re irreplaceable.
- Dollar-cost Averaging: This is consistently put in a specific amount of money in the markets on monthly bases regardless of where the economy is. This is will help you avoid missing major market movements, buying overbought or selling oversold securities, and making emotional decisions.
To conclude, a recession is actually not something to be feared if you are prepared for it, in fact a number of people became immensely wealthy from recessions because they knew how to profit from it. Even though this article does not constitute as financial advice, it’s paramount that you speak to your financial adviser and take this recession speculation seriously. Let’s all better prepare ourselves for any financial adversity as we enter into a new decade. Happy New Year!
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Available from: https://www.youtube.com/watch?v=PUB3pFA_RBA&t=979s
Fred. (2019): 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity. Federal Reserve Bank of St. Louis.
Available from: https://fred.stlouisfed.org/series/T10Y2Y#0
Kobo, S. (2019): What is an inverted yield curve and what does it mean for SA? Moneyweb.
O’Brien, N. (2019): The 2020 Recession: How To Prepare For The Next Economic Crash. Nate O’Brien.
Available from: https://www.youtube.com/watch?v=PTfa-rT5RXo
The Economist. (2019): What will be the biggest stories of 2020? The Economist.
Available from: https://www.youtube.com/watch?v=59ZrMEjktsA