our best defence against a recession is to structure your financial life according to some basic principles: save up for a rainy day, don’t put all your eggs in one basket and sharpen your resume.
The last recession scarred me. I was just about to graduate from university when it hit in 2008: the fallout from the subprime mortgage crisis created a deluge of fear, anxiety and pure panic from all corners. The S&P 500 plunged by 57%, U.S. GDP declined by 3.8% and employment dropped by 6%. Similarly, in the EU, GDP sank by 4.4% in 2009 and they lost about 6.7 million jobs from 2008 to 2013.
Never mind that Canada barely suffered compared to the United States and Europe (Canada’s GDP fell by 3.6% for only three quarters across 2008 and 2009 before recovering, while employment dipped by just 1.8% in the same time frame); mass uncertainty still swept the air. Homeownership and retirement plans washed away and headlines screamed that there were no more jobs to be had. The only sensible course of action was to hide out and let it all rumble over. I enrolled in graduate school.
Eventually, the global economy did recover. But it never forgot.
Since then, the U.S. has been in its greatest-ever period of economic expansion. The stock market hit record highs in both Canada and the U.S., while unemployment figures are at near-historic lows around the world.
Ironically, those positive data sets just appear to be fuelling widespread disquiet that a recession is just around the corner. After all, what expands must contract and we’re well overdue for a recession, which traditionally hits every eight to 10 years.
Sometimes it felt like we’re all on a plane clutching the armrests of our seats, just waiting for turbulence.
And then it happened—the fire-starter that we’ve all been waiting for. A new virus emerged in December and spread outward from China, stoking fears of a global pandemic. The stock market reacted spastically in response to potential quarantines, supply chain disruptions and travel restrictions. The DOW tumbled more than 3,500 points the last week of February, only to quickly recover by Monday of the following week, only to again plunge 1,1000 points on March 5. Both the Federal Reserve and Bank of Canada slashed interest rates by half a percentage point.
Now the question on everyone’s mind is: is a recession just around the corner?
What is a recession?
Technically, a recession is two quarters of negative GDP growth. And since it has to last for six months to even qualify, you may not even notice you’re in the midst of a recession until it’s almost over. Most recessions aren’t as serious as the last one we had; they usually last for just under a year.
But part of the reason we’re all so on edge now is because of what’s often thought to be a harbinger of recession: the yield curve inverted last year, for the first time since 2007.
What is an inverted yield curve?
An inverted yield curve simply means that interest rates on long-term bonds become lower than the interest rates on short-term bonds.
Typically, the opposite is true: you get a higher interest rate on long-term bonds because you’re taking on a greater risk; interest rates could rise over time while you’re locked into a lower rate. Conversely, there’s less risk in lending out your money at a fixed rate for a shorter term of a year or two; rates usually change incrementally and don’t swing erratically.
So, it’s really strange when interest rates for short-term bonds are higher than rates for long-term bonds—it’s like saying the near future will be riskier than the long-term. And an impending recession is one of the only reasons why that would be the case.
Indeed, the media clamour would have you believe an inversion of the yield curve is a portent equal to three bloody crows standing on a spire. But while the phenomenon has been somewhat predictive of a recession in the United States, it’s been less prophetical in Canada, says David Macdonald, an economist with the Canadian Centre for Policy Alternatives.
In other words: no one can see the future in a crystal ball. The yield curve doesn’t foretell anything. When a recession will hit, why it will hit, and how deeply it will affect you are all questions that no one—not economists, not analysts and certainly not your brother-in-law—can predict with the remotest bit of accuracy. (If they could, we wouldn’t have been so caught off guard in 2008.)
What will a recession look like in Canada?
We’ve had nine recessions since the last World War, says Craig Alexander, chief economist at Deloitte. Three were light, three were moderate and three were severe.
The cause of a downturn is what determines its magnitude. A single over-leveraged market—think early-aughts tech sector, for example—will lead to a milder recession than would a massive imbalance in the economy, as was the case in 2008 when subprime mortgage loans were packaged and sold around the world.
So, it’s impossible to say what the next recession will look like or how it will affect you. Each downturn is caused by a different issue in the economy, and your proximity to that issue influences the ramifications.
One thing is certain—some sectors will be hit far harder than others. Since Canada’s economy is primarily export-driven, any downturns that our trade partners experience will likely reverberate throughout our own country, especially in natural resources, commodities and manufacturing.
If the next recession is due to a shock in energy prices, the Prairies will probably suffer. If it’s due to a decline in housing values, Vancouver and Toronto will likely take a hit, as will related businesses such as construction and mortgage companies.
Across the board, we’re likely to see rising unemployment, especially among young and part-time workers. While mass firings are unlikely, says Macdonald, employers may put a freeze on new hires and reduce staffing through natural attrition. We may also see a dip in the stock market.
What will cause the next recession?
If the next recession is due to the COVID-19 virus, it would likely result from the need to shut down big cities to control its spread, as is already happening in China, Italy and South Korea, Macdonald says. If people stopped going to work, or going shopping, then we’re likely to see slow or negative economic growth.
Alexander and Macdonald, however, both identified the huge run-up of corporate, government and household debt as the biggest risk factors for the next recession.
U.S. corporate debt now equals half the nation’s GDP, or almost $10 trillion. Global government debt has almost doubled since the last recession to around US$66 trillion, or almost 80 percent of global GDP. Here in Canada, household debt is mostly in the form of mortgages and stands at $2.2 trillion, which actually exceeds our country’s GDP. Because the Bank of Canada recently slashed interest rates by half a percentage point, household debt is only likely to increase in 2020, as mortgages become cheaper.
But if, how and when that debt will spark an economic decline? Nobody knows.
Don’t be afraid of a recession
Fear of a recession can easily affect you more than an actual recession. So, whatever you do, don’t panic.
In December 2018, for example, the North American stock market was getting hammered, with Nasdaq, S&P 500 and the DOW sinking to 15-month lows. But in fact, the stock market returned around 20% just a month or two later.
“It was a very volatile risky year and the economic conditions weakened,” Alexander says. “If you sold in 2018 and didn’t invest in 2019 because you were scared a recession was going to happen, then you missed one of the best years in the stock market.”
How can you prepare for a recession?
The best way to prepare for a recession is to structure your financial life according to some basic, defensive principles (all conveniently summed up in popular sayings): save up for a rainy day, don’t put all your eggs in one basket and sharpen your resume.
“People need to be mindful that recessions do occur,” says Alexander. “The question is—if a recession hits, can you get through the 16 to 18 months that it will last? A recession is a valley and what you really need to do is get to the other side of the valley.”
Here are a few strategies to insulate yourself from the effects of the next recession.
Build an emergency fund
Aim to save three to six months of living expenses. While many Canadians are currently using their line of credit in lieu of a cash fund, be aware this may leave you in a precarious situation since credit may not be so easily available during a recession.
Make sure you have a diversified portfolio
That means across asset classes (i.e., stocks, bonds, real estate, commodities) and across securities and sectors (banks, energy, consumer goods, technology, etc.). Blue-chip, large-cap stocks in mature industries tend to weather economic storms better than smaller companies in newer industries—think healthcare and utilities over cannabis and blockchain.