How are you going to navigate a recession?
Your cash is getting eaten by inflation.
Stocks are way down for the year.
Bonds offer no place to hide.
Real estate is correcting too.
All signs are pointing to a recession.
How are you going to navigate a recession?
What is a recession?
While there is no consensus about how long a recession might last – there is general agreement on what it is and what it usually means.
Experts tend to declare a recession when a nation’s economy experiences negative gross domestic product (GDP), rising levels of unemployment, falling retail sales, and contracting measures of income and manufacturing for an extended period of time.
None of that is really good of course.
The C.D. Howe Institute’s Business Cycle Council National is an arbiter of business cycle dates in Canada. The council defines a recession as: a pronounced, persistent, and pervasive decline in aggregate economic activity – and did so back in May 2020.
Beyond C.D. Howe, there is a general consensus that a recession is officially judged as two consecutive quarters of negative economic growth.
While a bit painful, recessions are a natural phenomenon.
Check out this graphic, related to this point, from the Canadian Encyclopedia:
Recessions are therefore a natural part of how an economy works.
This makes recessions largely unavoidable – there is a natural cadence of expansion and contraction that occurs in our economy.
If a recession is happening – how bad could it get?
According to a recent RBC study, the average Canadian household could see a $3,000 reduction in their overall buying power in 2023.
This same report also predicts that Canada is entering a recession – soon.
During a recession, the economy struggles, people lose work, companies make fewer sales and the country’s overall economic output declines.
“Cracks are forming in Canada’s economy. Housing markets have cooled sharply. Central banks are in the midst of one of the most aggressive rate-hiking cycles in history. And while labour markets remain strong, employment is down by 92,000 over the last four months.” – RBC
The point where the economy officially falls into a recession depends on a variety of factors.
What causes recessions?
There is certainly more than one way for a recession to start. Here are some drivers:
- A sudden economic shock: An economic shock is a surprise problem that creates serious financial damage. The coronavirus outbreak, which shut down economies worldwide, is a good, recent example.
- Excessive debt: When individuals or businesses take on too much debt, the cost of servicing such debt grows. Growing debt can trigger defaults. The mounting housing bubble in Canada is a good example of this driver. Congrats Toronto, you win! Toronto is officially the bubbliest housing market in the world. Thanks to Visual Capitalist for this awesome graphic.
- Asset bubbles: When investing decisions are driven by emotion, bad economic outcomes can occur. This can extend beyond just real estate. Irrational exuberance inflates stock markets or asset classes in the stock market. When the asset bubble pops, panic selling can occur too.
- Too much inflation: Central banks like predictability. So does the stock market. Inflation isn’t a bad thing but excessive inflation is bad. Inflation was out of control in the 1970s. History might repeat.
- Too much deflation: While runaway inflation can create a recession, deflation can be even worse. Deflation is when prices decline over time, which causes wages to contract, which further depresses prices. Japan struggled with deflation throughout most of the 1990s and well beyond.
Will a recession trigger a depression?
These are not the same things though.
Recessions and depressions have similar drivers, but the overall impact of a depression is much, much worse. Depressions can last in years, not months or quarters. As far as I know, economists do not have a set definition for a depression even though they have occured.
The Great Depression started in 1929, and hit rock bottom in 1933. I took almost a decade after that for things to really recover and flourish.
Recession vs. Depression
A recession usually lasts for less than one year. The risk of a recession is that it can last for a longer time – turning into a depression. Though there are no hard and fast rules that define what constitutes a depression, it can be characterized as a long period of time with mass unemployment, falling prices, low incomes, and a persistent lack of confidence.
The C.D. Howe Institute’s Business Cycle Council created a classification system for recessions, grouping them together by category. According to the council: “Category 1 recessions have only a short, mild drop in GDP and no decline in quarterly employment. At the other extreme, Category 5 recessions involve extremely rapid contractions of the economy over an extended period of time.”
|Monthly Peak||Monthly Trough||Category 1 to 5|
|October 2008||May 2009||4|
|March 1990||April 1992||4|
|June 1981||October 1982||4|
|January 1980||June 1980||1|
|December 1974||March 1975||2|
|March 1960||March 1961||3|
|March 1957||January 1958||3|
|July 1953||July 1954||4|
|April 1951||December 1951||3|
|August 1947||March 1948||2|
|November 1937||June 1938||5|
|April 1929||February 1933||5|
Source: C.D. Howe Institute Business Cycle Council.
Canada has experienced five recessions since 1970.
These recessions usually last between three to nine months.
This means you should at least prepare for that.
How might a recession impact you?
Let me count thy ways.
- You might or could lose your job. Unless you are in a recession-proof industry, like frontline healthcare delivery, it might be challenging for you to find a new role when more people are unemployed.
- If you keep your job – your total compensation might not keep up. Even folks that keep their job, they might see wage freezes or changes in total compensation benefits that get eaten up with inflation.
- Investments are likely to lose value and be volatile. Investments in stocks, bonds, real estate and other assets can lose money in a recession, reducing your retirement savings/portfolio balance.
- Business owners tend to profit less. As an entrepreneur, you might have to fight for you business. Many businesses may find it hard to retain customers or attract new business. In turn, business owners may have to lay off some of their employees or cut hours in an effort to save money. This could even affect high-performing employees or the best-of staff.
- Bad luck and bad timing for new grads. If you’re a recent graduate, it could be a challenge to find any meaningful employment in your desired career path. Some of the companies you may want to work for could be laying off staff, which means hiring a new grad is the last thing they think about.
- Borrowing money tightens. With more people unable to pay their bills during a recession, lenders tend to tighten borrowing standards for mortgages and other loans. You might need a better credit score or a larger down payment to qualify for any loan.
What are the personal finance solutions for a recession?
To recap, there are many drivers for a recession:
- Sudden economic shocks
- Excessive debt
- Asset bubbles
- Too much inflation or too much deflation.
This means as a student of personal finance and investing on my site, you can consider the following, the flipside to these events:
- Build your savings to work against economic shocks. This way, with cash-on-hand or fixed-income assets, you have a larger emergency fund to cover periods of income disruption and any sudden income shocks to your household.
- Avoid consumer debt and kill off your highest debts. If you have a mortgage still, that’s probably enough. Pay it off. Consumer debt will be more costly in a recession when budgets are tighter. Where possible, as always, avoid lingering consumer debt.
- Practice diversification to avoid major asset calamity. All-in on a few stocks or stocks in just a few sectors (i.e., like tech as a growth sector) could be risky to your financial situation. Consider diversifying your stock assets to avoid owning too much of what could be one bad thing.
- Stay the prudent course. Mind your spending. Keep a budget. Be mindful of fees you pay to others. Recessions come and go, eventually, so don’t let your emotions get the best of you near-term when your financial plan is designed for the long-term.
How are you going to navigate a recession summary
I believe if your long-term financial goal is to build and enjoy a happy and healthy form of retirement, you don’t want to miss any chances for great returns. Those returns can come out of a recession.
The latest economic boom has been largely driven by housing. All good things usually come to an end.
Like this recently CBC article rightly pointed out:
“Like the stock market, the state of the housing market can often indicate the direction the economy is headed.”
I think from that article Murray Mullen said it best:
“We’re seeing cracks, we’re seeing some slowdown, we’re seeing consumers be a little more cautious right now with their spend,” said chief executive Murray Mullen.
“Recessions are a time just to pause and get things back in balance,” he said. “Sometimes it’s a necessary evil.”
- Increase our cash wedge as we strive towards semi-retirement.
- Control our debt burden/pay off the low-rate mortgage we have in the next 18 months.
- Maintain our modest savings rate for investment purposes.
We can all worry and loose sleep over another upcoming recession but by taking some small matters into our own hands, and understanding this recession is quite natural like the ones before it, it’s probably best we don’t.