Economic downturns are inevitable, sometimes even necessary -- but that doesn't mean we have to like them. When those reversals in "the big macro" arrive, they also trickle down to our little microcosms, where they can upend our finances, cost us our jobs, and generally stress us out. And to give you a head start on your stressing, here's a fun fact: A large fraction of economists are expecting a recession will hit within the next year.
But don't panic. In this "What's Up, Bro?" segment of the Motley Fool Answers podcast, cohosts Robert Brokamp and Alison Southwick review eight features of recessions, and not even half of them are bad news. If you're ready to take advantage, a cyclical calamity can also present you with opportunities.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.
This video was recorded on Sept. 10, 2019.
Alison Southwick: So, Bro, what's up?
Robert Brokamp: Well, I'll tell you what's not up: interest rates! They're not up! Did you know that last month, for the first time ever, the 30-year Treasury yielded below 2%? Historic low. You wonder, why is this happening?
Southwick: Why is this happening, I'm wondering?
Brokamp: More and more concerns about the dreaded R-word -- recession. These days, if you took a survey of economists, about a third would say that they expect a recession at some point in the next year. What is driving that concern? Well, there's that trade war that's been going on. A recent study from the Federal Reserve estimates that it could actually knock about 1% off GDP up through 2020. Plus, we've had a pretty long expansion. Unless something happens over the next few months, this will be the first decade since the 1850s -- when they started paying attention to such things -- that we didn't have a recession.
How is that reflected in the bond market? Well, people fly to the bond market for safety. It drives down rates. In particular, these days, longer-term rates are actually lower than shorter-term rates. That means the yield curve is inverted, which has historically been a pretty accurate precursor to a recession. It usually takes a while, almost a year. But when you see an inverted yield curve, historically, chances are, you're going to see a recession in the next year or two.
Southwick: You sound so smart when you say, "inverted yield curve." I think I'm just going to start dropping that into conversation. Don't you think, Rick? Doesn't he sound like smart? [laughs]
Brokamp: That said, there have been a couple of false positives, where there was an inverted yield curve and there was not a recession. Regardless, at some point, there will be a recession. What does that mean for the average person's finances? We're going to talk about eight things that usually happen during a recession.
Southwick: Whoa, eight! Let me get comfy!
Brokamp: No. 1: stocks drop. Generally speaking, they start to drop about six months before the recession. According to the Capital Group, which is the folks behind the American Family of Funds, they start to rebound about six months into a recession, and they recoup their losses over about 18 months. So, usually, it's not too bad. The average loss during a recession, depends on how you look at it, but it's like 20% to 30%. Some have been very shallow. That said, the last two recessions we experienced -- the .com crash and the Great Recession -- were declines of 50%, and it took more than five years for the stock market to recover. Basically, this is why we always say that any money you need in the next few years should not be in the stock market.
No. 2: rates also drop. That's already started. They could continue to go lower. The Federal Reserve is going to meet in a week. Everyone expects them to drop the Fed funds rate by 25 basis points. Maybe 50 basis points. Around the world, there's this phenomenon of negative interest rates. Hasn't happened yet in America. But Alan Greenspan recently just told CNBC it's only a matter of time, so rates could keep dropping. What does that mean? Ideally, you could refinance your home, get a lower mortgage. Good time to refinance your car loan, student loan. Hopefully, your credit card rates will also go down. So, that's actually pretty good news.
No. 3: bonds go up, depending on the bonds. Generally speaking, when rates go down, bonds go up. We've seen that this year. Bonds have actually made almost 10% so far in 2019, which is a pretty extraordinary return for bonds. In 2008, when the S&P 500 went down 37%, bonds went up 5%. The only thing is, it does depend on the type of bonds. Treasuries do well. Corporates do generally OK, but it depends on how far you go down the credit rating. When you're looking at junk bonds, they do not do so well. They lost 20% in 2008. So, the more you are concerned about a recession, the more you should keep your bonds to Treasuries or highly rated corporates, or maybe just play it safe with cash.
No. 4: the price of your house actually might go up. I think a lot of us were stung by the Great Recession, and that was really the first time we saw a nationwide drop in home prices. The truth is, when you look at recessions historically, home prices actually hold up well. There was a study by Mark Hulbert, and he published it in MarketWatch, where he found that when you look at the Case-Shiller Index of home prices, it actually does better during stock bear markets than it does during stock bull markets. Historically, in most cases, your house is actually a good hedge against a recession, against inflation, and a stock market drop. However, during the Great Recession, what we saw the last time, that was not the case. There will always be outliers. But generally, houses hold up pretty well.
No. 5: inflation generally goes down. This is the upside of downtrodden economy. Prices generally do go down. What does that mean for you? Well, it's actually a really good time to make a major purchase, buy a car, get an appliance. All those folks are out there trying to get consumers to come in and buy something. If you have the means and you're looking to make a big purchase, a recession is actually a good time to do it.
No. 6: employment goes up. According to The Washington Post, the unemployment rate has risen 2.4% on average during the 11 recessions since World War Two. It goes up slightly. Of course, sometimes it can be worse. What was the worst since World War Two? It was the last one, the Great Recession. Unemployment went from 5% to 10%. On average, people were out of a job for six months. That's a good frame for what we talked about, the emergency fund, how much you should have. The way to prepare for this, of course, is to have the emergency fund, but also to keep your debt levels manageable. That's where people get in trouble -- they have high debt levels, they lose their job, and they can no longer pay the mortgage or anything else, so they lose the house, or they lose the car. So, have the emergency fund, and keep your debt levels manageable.
No. 7: employers reduce benefits. Even if you are fortunate enough to remain among the working, chances are something will get reduced. You may not get a raise, you may not get the bonus, your 401(k) match might get eliminated. That's happened here at The Motley Fool, then The Motley Fool kindly made up for it retroactively. That usually does not happen. You'll see stuff like that. You may not have a fancy holiday party at the end of the year. Might be in the conference room.
Southwick: We've done that too here at The Motley Fool.
Brokamp: Potluck instead of a fancy party downtown. Even if you do manage to keep your job -- and most people will -- you do have to expect that you'll probably have to tighten your belt a little bit some way or another.
No. 8: in a recession, stocks do go back up, and the economy eventually recovers. For those who have the cash on the sidelines, and the guts, buying stocks in the middle of a recession can actually be one of the best investments you ever made. But you can't wait until the recession is over, because the stock market begins to recover before the overall economy. But, history has shown us, the economy will recover, you will be able to go back to the fancy holiday party at the hotel downtown, and stocks eventually will recover and reach higher highs.
Southwick: On that last point, that is where I think some listeners hear, "I should try to time the market," as opposed to, "I should just be always in a good financial position where I can continually put money in and invest it so that I can be investing in the lows and the highs." We get questions all the time about people trying to time the market.
Brokamp: Right. It's very difficult to do. I would not recommend anyone do that. What I recommend is that someone always have a little bit of money out of the stock market so that A, you either have it as an emergency fund if you need it; or, it's the dry powder that you can use to buy stocks when prices are down.
Southwick: Is that what happens at the Brokamp household?
Brokamp: Generally what happens at the Brokamp household.
Southwick: Have you been able to do that in the past?
Brokamp: Yeah, yeah. But there's a cost to that right. Having some money out of the stock market has cost us during this expansion. Like many things related to margin of safety, whether it's insurance or having some cash on the sidelines, some of it is just peace of mind. I just feel better knowing that I have that optionality.
Southwick: Is that what's up?
Brokamp: That, by the way, is what's up.