After a decennia of great economic prosperity that has been somewhat artificially prolonged by certain countries it seems we are finally at the Eve of the next Recession thanks in part to the coronavirus (Covid-19). The S&P 500 dropped 10,5% in week 8. That sounds like a nightmare but it really is not. In this article I will explain why the coronavirus is causing the next recession and what you can do during this downfall of the economy.
How is Covid-19 causing a recession?
Although the virus is not as lethal as its siblings SARS and MERS it is causing a fear of panic around the globe. China has taken extreme measures to prevent the spread by putting entire cities into quarantaine and ordering people to stay inside. Following China’s example, more and more countries are considering the same measures of locking down area’s like Italy. Both China and Italy are huge countries with huge economies. If nobody is allowed outside, products aren’t produced or shipped. This is a large part of economic traffic, especially in China which is suffering from the virus the most. The fact that China is such a large economy means it has a lot of economic connections with the rest of the world that in turn also suffer from the issues within China. For example, have you noticed that packages you ordered recently that come from China are delayed or the whereabouts of the package is unknown? Thats because of the virus. There are ships fully loaded with products that aren’t being shipped because there aren’t enough workers or because the ships aren’t allowed to leave the harbour due to the chance it might further spread the virus. This results in a simple problem with a large impact: the economy comes to a stop or slows down significantly. Because of globalisation this in turn has a large impact on the world economy and results in an overal slow down of the world economy.
Not only the slow down of economic activity in China is a problem. People are starting to cancel or delay their vacation plans. Insurance doesn’t cover the coronavirus because it is an “act of God”. Very few people want to travel to infected area’s, not only because of the virus but also because you might be stuck there for 2 weeks due to quarantaine measures. This results in decrease of tourism and thus of flights (look at the stock prices of travel agencies and flight companies!), local tourism such as attractions and restaurant spending even oil because less travel means less necessity for fuel. You might notice these symptoms directly at your fuel station or normally touristic area’s. Some countries like Italy are heavenly depended on the tourism industry and especially when larger economies like Italy take an economic hit, they can drag the rest of the world with them into a recession.
The interesting thing about recessions is that they always come out of nowhere and when you least expect it. Although signs of economic recession have been shown for a while, for example for a brief moment in 2018, the coronavirus could be the final push it needs.
Risk and opportunities during a recession
I am not going to lie: some people are going to suffer from a recession. However, that does not mean you have to be one of them. It is quite easy to prepare for a recession and there are even opportunities to profit from a recession. I will start with the risks of a recession and how to prepare for it but feel free to skip ahead to how you can profit from the opportunities that arise during a recession.
Risk and how to prepare
A recession is caused by a slow down in economic activity. In practice that means that people buy less goods and therefore less goods need to be produced. Obviously if less goods are sold that means there is less turnover for companies which means that companies are less likely to make a profit when the costs stay the same. If you are a small time business owner that means you need to be wary of a reduction in your turnover and profit, especially if your income depends on it.
That’s where the second risk is, the profitability of companies. If you have stocks in companies that means that you will receive less dividend on your investments and the price of stocks might fall. In the worst case scenario that can results in bankruptcy which means you can lose the money you invested in those stocks.
A company will go bankrupt when the turnover decreases while the costs stay the same. A common solution is therefore to reduce costs and unfortunately that often results in large layoffs of employees. Anyone who is employed is at risk of losing their job in times of crisis. Although some jobs are less likely to be at risk please be aware that management makes some weird decisions to save costs that might not always be logical. Even though you might be an employee the company can’t miss, that doesn’t mean they won’t fire you. This is generally the largest issue for most people during a recession. The issue is not necessary that you get fired, but a lot of people from a lot of companies get fired. That means unemployment ratings increase and the amount of job openings decrease which means it also becomes increasingly more difficult to find another job. That means your income is gone or in a good social welfare state your income is decreased and it becomes more difficult to get back to your old income. Yet just like with companies, your costs stay the same. Your rent or mortgage still needs to be paid and you also still need to eat and pay for insurance which can results in problems. In turn if people have less money to spend, people buy less goods which creates a vicious circle of less necessity to produce goods, employee costs cutting and so on.
Now how to prepare for all of this? Whoever you are you need at least 6 months of usual costs in savings. So if you spend on average €2.000 per month, that means you need €12.000 in savings that you can access whenever you need it. If you don’t know how much you spend on average, I suggest you have at least 6 months of your average salary in savings and perhaps start working on a budget with a financial advisor. Why do you need to save that much? These savings are mainly to cover your expenses when you are temporary out of a job or you don’t have enough income from your company and if you don’t have any other forms of income (e.g. social welfare income). This allows you the time to find another job or for your business to cut some costs to increase your income again. This doesn’t mean you can just sit back, there are plenty of people who are unemployed for more than 6 months and businesses often struggle for multiple years. It also still means you will have to be very careful with your expenses until you have another job but it means you don’t have to sell everything you have in order to be able to live in your house.
Of course this doesn’t solve the issue that your investments are at risk of decreasing in value. The solution is very dependent on why and how you invest. A more general way of decreasing your risk is by investing in broad indexes instead of individual stocks. The chance that the top 500 companies in the US go bankrupt is a lot smaller than the chance that a medium sized unknown company goes bankrupt. In general, a more spread portfolio with a lot of different stocks from different companies in different industries is much less risky. If you want to invest long term, generally you don’t touch your investments in a recession. What you can do is rebalance your portfolio a bit with more defensive investments like treasury bonds and invest a bit less in high risk investments like individual company stocks.
Opportunities in a recession
So what are the opportunities in this period of depressing unemployment rates, inflations and bankruptcy? Well that depends on the cause of the recession. For example, take the Covid-19 crisis. Yes, part of business has come completely to a stop but have you seen the surgical mask business? Or the alcohol gel business? The surgical gloves sales? They can’t keep up with the demand! So how about instead of protecting yourself, you start buying those items in bulk and sell them once the virus is in your area for a reasonable profit? Don’t overdo it, because you might get in trouble with law enforcement if it gets too extortion. But profiting a bit from a crisis like this is not wrong and can earn you a pretty penny on the side. Just buy a box of 50 and try to sell it for double the price. That way you are probably still on time to sell out before the crisis is over. Because there is going to be a lot of product left once the crisis is over. Once everything is on sale because they made to much and the demand is decreasing, perhaps consider buying a small stock for a discount. Virus-outbreaks happen every once in a while (SARS, MERS, Ebola, Mexican Flue etc.) and those surgical equipment generally has a very long shelf life. There are always opportunities in a recession. The 2008 recession was the reason Bitcoin took off, people lost faith in the financial system and designed and started investing in a different financial system. Look for those opportunities at the start of a recession.
Of course not everyone is as prepared as you will be after reading this article. This means that people are going to lose their home who need to find another house. This is likely going to be a rental house. If you have some money to spend, consider going in the real estate business. Real estate is always a good investment to start with but rent generally increases during a recession whereas housing prices fall due to the increase in sales and decrease in demands.
Lose your job and start a company! Always had this great idea for a company or product? When you lose your job and find it difficult to find another there is a perfect opportunity for you to try it out. Want to make your own custom made products like soaps, knitting artwork or wooden furniture? Start with small weekly production and sales targets you know you can achieve and increase the target a bit each week. Are you more of a service industry type and instead want to do consultancy or give classes in something your good at? Start with one class and getting it full or one consultancy customer and gain feedback to improve the next class or consultancy project. Then do another one. Start building your portfolio to show clients. Also don’t forget to save some of the money you earn for taxes! It is an ugly surprise to pay at the end…
It is natural to worry about a recession. People lose their jobs and you hear a lot of negative news about companies. The most important thing to remember is that a recession is just part of an economic cycle and that a recession generally doesn’t last more than 5 years while economic expansion generally lasts 10 years. If you look at the past 50 years human kind has only gotten better and so will your life.