In March, the market was in free-fall and no one knew where the bottom was. There were massive plunges, big enough to trip the kill switch three times in a single week. All the headlines seem bad. You can hardly blame the average person from thinking that we are about to plunge headlong into a depression.
Many people are unaware of the actual terms of a depression, correction, or recession. I’ll explain what each term means and which one we are experiencing.
What is a Correction?
A market correction occurs when the stock market declines at least 10% from its 52-week high; stopping an upward trend. A correction is not the same thing as a stock market crash. A crash occurs when there is a loss of at least 10% in a single day. A correction happens over a longer period.
What precedes a correction? Overly exuberant investors artificially driving up stock prices to levels that are not supported by fundamentals. As the market climbs, more investors start joining the party hoping to get in on the returns. The correction happens when reality sets in and prices come back down to earth.
Market corrections happen frequently. On average, they come every eight to twelve months and last an average of 54 days. Since 1920, the S&P 500 (on average) had a 5% decline three times a year, a 10% correction once a year, and a 20% drop every seven years.
See? You have lived through several market corrections in your lifetime and probably did not even realize. A market correction does not mean the sky is falling. A correction is necessary sometimes to allow prices to more accurately reflect the actual value of the underlying assets.
What is a Recession?
The formal definition of a recession is two consecutive quarters of negative economic growth as measured by the gross domestic product. GDP is the total monetary value of the goods and services a country produces over a specific period. This represents the size and health of a country’s economy.
There are other factors still that can indicate a recession. These include high unemployment, the stock market, trade wars, credit availability, and industrial output.
Recessions get more attention than corrections; but they are still a necessary part of the economy and business cycles. They are not uncommon. Since 1900, we’ve seen a recession on average every four years. Since World War II, the average length of a recession has been about eleven months. That number is skewed thanks to the Great Recession (which lasted eighteen months).
What is a Depression?
Depressions are harder to define; largely because they happen so infrequently. Most economists agree that depressions can be constituted by an economy showing little to no growth for more than a few years, large increases in unemployment numbers, a major decline in aggregate demand, and a corresponding decline in production.
The last real depression was “the big one”, which was the Great Depression in the 1930s. At its height, U.S. production fell 47%, the GDP fell 30%, and unemployment was above 20%. The Great Depression lasted a decade from 1929 to 1939.
Where Are We Now?
We are not “officially” in a recession currently. But even before the pandemic, there were signs that we are headed for a recession. The indications of a possible recession have been made worse by the pandemic. First quarter GDP fell 4.8%. Analysts at Goldman Sachs predict that GDP will drop 24% in the second quarter.
No one can predict the future, but it is possible to make some assumptions based on the tea leaves available to us.
Consumers drive the economy. When they are optimistic about the economy, they spend more money. When that confidence erodes, they spend less. Right now, no one is spending money outside of places like groceries and drug stores. The University of Michigan's consumer sentiment for the US was revised in April to 71.8. This is the lowest reading since December of 2011. In February of 2020 it was at 101.
Factories Slow Production
America has lost much of its manufacturing economy, but we do still have factories that produce wide variety of goods. With no one spending, there is less demand to manufacture. Undeniably, many factories have been totally shuttered by the stay-at-home orders.
Perhaps one of the most frightening statistics to come out during the shutdown are the unemployment numbers. The former record of people filing unemployment claims in a single week used to be 695,000 (set October 2, 1982). This year on the week ending March 29th, we saw 3.3 million people file claims.
Claims are now over 30 million. In California, 2.8 million people have filed, 14.5% of the state’s labor force. Yikes.
New Car Sales Decline
People need transportation no matter what the economy is doing. But when consumer confidence drops, they turn to used cars. New car sales fell sharply in March. Fiat Chrysler’s first-quarter sales fell 10%, GM’s 7%, and Toyota’s 9%.
Credit Card Debt and Late Payments Increase
With millions of people out of work and roughly 40% of Americans without an emergency fund, people are going to reach for their credit cards. This means more debt and more delinquencies, particularly if people cannot get back to work for weeks or months.
Last year in 2019, credit card delinquencies were at their highest levels in seven years. In the second quarter, 5.2% of accounts were 90 days or more past due. Look for these numbers to jump in 2020.
What Steps Should You Take?
Things do not look rosy; but there is no need to panic. There are a few things you can do to help protect yourself ahead of the likely recession.
Fortify Your Emergency Fund
If you do not have a six-to-twelve-month emergency fund (of necessary expenses), it is a good time to build it up. Even if you are still working, that could change, and your emergency fund can keep you afloat until things return to normal.
There are not many places to spend, so plenty of us are probably seeing extra money in our checking accounts these days. But given the uncertainty, cutting spending further is prudent. For some, that might mean cutting back on small things like subscription boxes. For others, it might mean tough choices like public versus private school for your children.
If you have the option to suspend payments on things like your mortgage or student loans, it is worth investigating. Even if you can continue paying these expenses, it could change. These savings could be used to boost your emergency fund.
Update Your Resume
Even if you are still working, it is a good idea to update your resume and reconnect with people in your network. Opportunity can be born of disaster and you want to be in a good position to jump on an opportunity if it comes your way.
Review Your Asset Allocation
Check to make sure that your asset allocation is concurrent with your risk tolerance and retirement timeline. If you are nearing retirement, you may want to be more conservative in the event of a recession.
If you are still decades away from retirement, your money has plenty of time to ride out whatever is about to happen. This means you can consider being a bit more aggressive and get some great deals while prices are low.
Stay the Course
If you work with a CERTIFIED FINANCIAL PLANNER™, the two of you have worked together to create a plan that will allow you to meet your financial goals. These plans consider events that can influence your portfolio. Do not panic and allow a possible recession to undo your careful planning. Remember, at Paradigm Wealth Partners we are here to help in any way possible.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing involves risk including loss of principal.
Photo credit to the Associated Press.