Recession
00:00:00.000 | What is up everybody not the stock market it's Sam from financial samurai and in this episode
00:00:06.120 | I want to talk about the probability of a recession happening what we should do if a recession comes and the difference between a
00:00:13.240 | Recession and a bear market because there are some subtle differences
00:00:16.700 | So I think the probability of recession happening over the next 12 months is about 70%
00:00:22.640 | And the reason why is due to four things one the yield curve has flattened
00:00:28.600 | So the spread between the two-year Treasury yield which is on the shorter end and the 10-year Treasury yield
00:00:34.660 | Which is on the longer end has compressed to the narrowest margin since March 2020
00:00:39.480 | so a flat or
00:00:41.800 | Inverted yield curve so inverted yield curve is when the short end yield is higher than the long end yield is a reliable
00:00:49.480 | Recession indicator if you look at history you look at the st. Louis Fred chart
00:00:55.020 | every time the yield curve has inverted almost every time it looks like over the next 12 months a recession has occurred and
00:01:02.440 | Why is that? What is the significance of an inverted or flat yield curve?
00:01:07.040 | Well when it's inverted it means that people are not bullish or optimistic about the future
00:01:12.800 | So they're unwilling to invest in the future
00:01:15.640 | Because they're uncertain about the future right the worst case World War three happens
00:01:21.360 | You know one to ten percent chance some people say and if that happens, there's gonna be a tremendous amount of pain
00:01:27.920 | So instead people want to invest in shorter duration. They're gonna accept lower returns for the higher probability that they'll get their money back
00:01:35.680 | Thankfully expectations for aggressive Fed rate hikes over the next 12 to 24 months have declined
00:01:41.520 | However, even if the Fed doesn't hike at all
00:01:44.040 | The yield curve could still turn negative since the Fed doesn't control the Treasury bond market
00:01:49.780 | The market does and this is something very important for people to understand when everybody
00:01:54.920 | You know might freak out about the Fed hiking rates and they're like, oh no mortgage rates are gonna go up
00:02:00.580 | Well, that's not necessarily the case at all because the Fed doesn't control the bond market the market does you and I do
00:02:06.900 | The Fed could be behind or ahead of the curve
00:02:10.560 | You just don't know I would rather trust the market then, you know
00:02:14.160 | Seven Fed board governors the second reason why a recession could be imminent is because long bond yields are not spiking with surging
00:02:21.880 | energy prices
00:02:23.260 | Energy prices are obviously surging due to the war in Ukraine
00:02:26.840 | Given Russia is one big gas station leaving economic sanctions will hurt the global supply of oil and gas
00:02:33.380 | Now President Biden is talking about cutting off
00:02:36.540 | Imports of Russian oil and gas and the EU is talking about reducing its dependency by 65%
00:02:43.500 | So as a result, there's less supply and prices go up usually in a surging inflationary environment
00:02:49.820 | Longer term duration Treasury bonds would normally increase as bonds sell off
00:02:54.660 | however
00:02:55.460 | the 10-year Treasury bond yield actually declined from about 2% to
00:03:00.420 | 1.7 percent and it just can't seem to get past 2% and the reason again is that the fear of a recession
00:03:07.940 | The fear of losing money is greater than the fear of higher inflation
00:03:12.620 | in other words investors would rather own safety and lose in real terms rather than invest in risk assets and lose in nominal and
00:03:20.580 | Real terms. Alright, so let's say you buy a 10-year Treasury bond that yields 1.8%
00:03:25.700 | But it yields a negative 5.7 percent real return because inflation is at 7.5%
00:03:32.260 | People are saying that's preferable to losing a nominal 20% in the stock market because it's tanking and a negative
00:03:39.660 | 27.5%
00:03:41.700 | Return real return because of inflation
00:03:44.420 | So for many of us if we could rewind time
00:03:47.300 | We could say well the wisdom of investing in I bonds paying 7 plus percent is pretty darn good and the wisdom
00:03:54.680 | Investing in municipal bonds that are double tax-free
00:03:57.420 | Pretty darn good in this scenario in the future when you're thinking about investing in a low-risk asset
00:04:03.560 | Don't think so much about making a small nominal or real return
00:04:09.140 | Instead think about how much of your capital you can protect on the downside a third reason why a recession might be imminent
00:04:16.420 | Negative real wage growth is a recessionary sign
00:04:20.140 | So although real wage growth is strong for lower income earners real wage growth overall is negative due to high inflation
00:04:27.220 | We're just not making as much as inflation
00:04:30.020 | However, unlike with negative real mortgage rates, which is great for real estate negative real wage growth is negative for the economy
00:04:38.140 | Right things are just simply getting more and more expensive even though you're making more and more money
00:04:43.180 | There is a chart in my link post from Bank of America
00:04:46.260 | That says if real wage growth is still negative by summer the chance of a US recession increases
00:04:51.840 | Well, I think there's probably a 90 plus percent probability that real wage growth will be negative in
00:04:58.940 | 45 months therefore the chances of a US recession is
00:05:03.780 | Pretty high based on this data point and this data point is also a great reminder to continue to try to
00:05:09.420 | increase the percentage of your income coming from
00:05:12.300 | Investments and not labor because income from investments are much easier in terms of moving with inflation
00:05:20.140 | Whereas income from your job, you know, there's a lot more friction. You've got to be a good employee
00:05:25.820 | You have to have good relationships with your manager. You've got to
00:05:30.260 | Chart what you've done for the company and you've got to ask for a raise and you've also got to probably thread into job
00:05:36.540 | Hop or actually do job hop so it's much harder to get market wage
00:05:41.140 | Whereas when it comes to investing it's much more automatic and the final point of why a recession could be imminent
00:05:47.860 | Is that drastically higher energy prices have historically preceded a recession another great chart in the post goes back to?
00:05:56.300 | 1970 and if you see every single spike in oil Brent price, you know over 104 a
00:06:01.980 | Recession looks to be highly probable over the next 12 to 24 months right now oil is spiking to
00:06:09.420 | $130 a barrel could go higher and higher who knows but what we do know is that you know prices at the pump are
00:06:17.420 | Going, you know, it's over $4 per gallon average in America, which is still much lower than in the UK
00:06:23.460 | Let's let's not take our prices for granted. But you know in coastal cities. We're talking $6
00:06:29.460 | Price per gallon which is a lot and that just squeezes the consumer and thankfully, you know heating costs for your home should go down
00:06:37.340 | Because we're entering spring and summer months which use less energy
00:06:41.980 | But then again, there's cooling costs to deal with for probably half of the country
00:06:46.320 | So given I believe there's a 70% chance a recession is coming over the next 12 months
00:06:51.380 | There are some things you should really think about
00:06:53.580 | The main thing is if you have a job is to develop your relationships now with the people who control more power at your organization
00:07:01.860 | You know reach out to people before you need something instead of after you need something right now
00:07:08.080 | The labor market is robust. No doubt about it
00:07:11.180 | If you go on the streets people are spending their money having a good time because kovat is waiting. Thank goodness, right?
00:07:17.940 | However, we're trying to think forward. We're trying to think over the next 12 months
00:07:22.220 | Just put yourself in the shoes of the CEO or your direct hiring manager who has seen their share price go down
00:07:30.340 | 20 to 80 percent or they've completely round-tripped any gains they made since the pandemic began in 2020
00:07:38.620 | But the labor force is much higher and then profits are waning or slowing down
00:07:44.660 | so it stands to reason very logically that
00:07:48.660 | Managers are gonna try to make employees do more with less
00:07:52.420 | They're gonna slow down their hiring and as a result, you know wage pressure will slowly
00:07:56.980 | Decrease and if things get too bad or some companies just have just kind of crushed
00:08:02.500 | They're gonna start letting people go and historically even in good times companies would let go
00:08:07.780 | Five to ten percent of their worst performers every single year. This is like the GE Jack Welch tradition
00:08:14.460 | And if we go into a recession, obviously that's going to increase so you've got to be thinking ahead
00:08:19.740 | Six twelve twenty four months and all the signs are pointing towards a slowdown
00:08:24.820 | So it's wise for you to boost your cash reserves boost your defensive assets
00:08:30.980 | Network strongly and look for other jobs now before the rush
00:08:35.420 | Happens where everybody is starting to freak out and look for new jobs
00:08:40.060 | Even though I believe there's a 70% chance a recession will come over the next 12 months
00:08:44.460 | That still means there's a 30% chance that there will be no recession
00:08:48.780 | We're gonna be able to navigate this cruddy time right now. Maybe the war ends over the next couple of weeks
00:08:55.620 | maybe there's just peace on earth again and
00:08:58.540 | You know things stabilize the VIX or the volatility index is currently trading above 30. That's an elevated level
00:09:06.540 | But that's actually good
00:09:08.140 | So the VIX measures the level of risk fear or stress in the market when making investment decisions and when it is elevated
00:09:14.900 | Historically if you're buying when the VIX is at 30 or above over the next 12 months
00:09:20.180 | There tends to be a really good return on the S&P 500
00:09:24.260 | Specifically we're talking about a 15 to 25 percent return
00:09:28.340 | Well, you know, hopefully that doesn't happen because hey the S&P 500 is already down about 15%
00:09:34.140 | The Nasdaq is already down over 20% and speaking of the Nasdaq. It's officially in a bear market
00:09:40.060 | So what's the difference between a bear market and a recession not too much?
00:09:44.980 | but if you are an investor who has a predominant portion of your net worth in risk assets or if you're a
00:09:52.740 | Retiree who is depending on most of your investments to fund your lifestyle
00:09:57.500 | Then a bear market is worse than a recession at the margin here. I look at my own example
00:10:04.060 | I don't have a day job. Yeah, my wife could fire me, but that's probably not wise
00:10:09.020 | It's probably not gonna happen, but I don't have a day job to fear losing
00:10:13.060 | When you're in a recession
00:10:14.900 | The biggest fear is losing your job and losing money in your investments that double combination is pretty bad
00:10:22.380 | Because if you lose your job
00:10:24.100 | You don't have that disposable income power to buy on the low and to make up for your paper losses
00:10:29.460 | So if you have a day job, you should fear a recession more if you don't have a day job
00:10:35.100 | Then you should fear a bear market more. However, obviously either scenario is a suboptimal scenario
00:10:41.620 | It's just the way you want to think about things going forward
00:10:44.820 | Personally, my goal is to continue living the way I want even if a recession or a bear market arrives
00:10:51.260 | Living the way I want means spending more time with my little ones and less time working online
00:10:56.540 | I also plan to travel more with my family to see my parents and in-laws, you know this summer
00:11:02.340 | I think is gonna be a boom time for travel
00:11:05.020 | I'll just be poor in the process right because my investments are going down
00:11:09.100 | Look, it really stinks to be losing money and losing our progress our financial progress buys us time
00:11:15.900 | And that's the most important commodity of all
00:11:18.340 | however
00:11:19.220 | I will conclude by saying the best hedge against a recession is to continue living every day with joy and
00:11:26.140 | Meaning thanks so much for listening. If you enjoyed this podcast, I'd love a positive review and a comment. It keeps me going
00:11:33.060 | Take care