Thursday, June 27, 2019

How the Recession Will Happen (and is Happening)

The snowball effect works in recessions, too.

Just last year, there was a hue and cry that there weren't enough truck drivers to haul all the nation's goods.  We need more!   Well, a year later, several trucking companies have gone bankrupt and FedEx is reporting a loss.  Even taking aside one-time write-downs, FedEx isn't doing well and has lowered expectations for the coming year.

The culprit?  People are buying less stuff.  Commerce is down.   In the car business, sales are off, and each company is trimming its sails for the coming storm.  GM smartly sold off its money-losing European operations and rightfully closed the money-losing Lordstown plant and dumped unprofitable car lines.  They know the Buick party in China will end soon, as nationalist fever increases and being seen driving an American brand is viewed as an act of treason.

It doesn't take much for a recession to start.   It is a cyclical thing, to be sure - and we are overdue for one.  During good times, people spend money.  The stock market goes up, and people feel good about their investments.  Why not spluge a little, when your stocks went up a few grand this month?   Why not buy more when your house just jumped up in value?   And hey, you can "cash out" on this "equity" by taking out a HELOC or refinancing your house!

So people spend, and the snowball effect kicks in.  More spending means more jobs, which means more profits, which means bigger dividends, which means higher stock prices, which means more consumer confidence and more spending.   It is a perfect feedback loop.

But eventually, the balloon has to burst - or at least deflate a bit.   People run out of money to borrow.  Once you have over-mortgaged your house and have two hefty car loans and a credit card balance, reality kicks in.   This happened to me in the early 2000's - we were having a grand old party, and then one day, "suddenly" it seemed the bills got a lot harder to pay.  It works that way - you can go along making the minimum payments on your debts for months, even years, until one day you can't, because the debt load has been steadily increasing.   It appears to be sudden, but it was a long time in coming - catastrophe theory in practice.

Once people stop spending - or just slow down - the results are predictable.   Companies stop hiring.  Then they start laying off.   Companies that are over-extended with debt may end up going broke.   More people are laid off.  The guy who is laid off stops buying stuff he doesn't need.  The company selling junk to him makes less money - and they lay off people as well.   Unemployed, the laid-off guy sells his stocks, depressing stock prices.  Maybe he sells his house, as he can't afford the two mortgages.

Or he stops paying on the mortgages, and the bank forecloses.  The bank unloads the house for below market value, depressing home prices.  Again, this takes time, so you don't see it happen overnight, but when it kicks in, it appears to be sudden.   Once home prices are depressed, consumer confidence drops.  People worry their house is worth less than the mortgage balance.  Some simply walk away from underwater houses.  Others cash in their 401(k) - further depressing stock prices - to hold on to their "home".

This is the pattern we saw in 2008, it is a pattern we will see again.  And you and I can't control this, not through any direct or indirect means.  It doesn't matter who is in the White House, recessions happen.   But this time around, deficit spending and tax cuts have delayed recession for a year or two.  Tariff wars will insure the recession will be worse and longer, much as they were in 1929.

So what can you do to protect yourself from recession?   Basically the same things you should do all along - minimize debt and have a plan to pay off the debts you have.   Cut back on spending on frivolous things like $1000 smart phones and $100 restaurant meals or $5 coffee drinks.   Diversify your portfolio, so if one thing goes bad, it doesn't take you out financially.   And as you get older, find more and more "safe harbors" for your cash.   And if something does drop in value, don't panic and sell it all, thinking it will go all the way to zero.  When you buy high and sell low, you lock-in your losses.

We are well-prepared for a recession.   We have no debt, so no one can take away our home or tow away our cars.  Everything is paid for.   We have a very diversified portfolio, and I have been selling off stocks in mine for a year or so now (including just the other day) so I am sitting on enough cash to survive for at least three or four years, without having to sell off stocks at a loss during a market crash. We try to keep our expenses low and a lot of the "stingy" habits we've learned since I started this blog in response to the last recession, are still with us.   I just bought a new hair trimmer - it cost $20, or less than the cost of one haircut.

By the way, the idea for that money-saving tip didn't come from some old  fart or some tech-y geek who didn't care how his hair looked.    Rather, it was a trendy friend of ours who lived in Atlanta (and now New York City) who always had the latest clothes and accessories and was up on all the things the kids are doing these days.  If it worked for him, it certainly can work for me.  Although maybe now that he lives in Manhattan, he's getting those $200 haircuts, I don't know.

We're ready for this recession.   But many others are not.  The last time around, I wasn't and we still survived.   And others will, too, but there will be much moaning and groaning about how "unfair" it all is, and how the government should, once again, "bail out" homeowners who refinanced their house to buy a Mercedes.   Cut the loan balance in half!  That's only fair, right?

Sadly, they will likely do this, too.   It is like the student loan thing.   Maybe some of these kids are stressed financially (but whose fault is that?).  But others, such as myself, were easily able to pay off their loans (over a decade!) because we majored in something useful and found jobs and worked hard.   Would it have been fair to pay off my loans (as Bernie Sanders posits)?   Worse yet, it is fair to the guy who works hard and scrimps and saves to pay off his loans that the unemployed guy smoking pot gets his paid off for free?   What about the guy who paid off his loans last year?   Doesn't he feel cheated that he didn't wait a year for Comrade Sanders to wipe out his debt!

But I digress.   The point is - and I did have one - is that what we consider "financial distress" in this country is "wealth beyond our wildest dreams" in 90% of the world.   We need to put our problems in perspective, today and in the coming months as things start to unwind.