The global economy is a house of cards. The 2008 financial crisis was just the first sign that things were not well. Since then, central banks have been artificially stimulating the global economy through quantitative easing and record-low interest rates to prevent another recession. But these measures cannot go on forever. When interest rates reach their lowest possible point, there’s no further that they can go down. With most central banks now ending their QE programs, we are approaching the end of an unprecedented period of monetary stimulus that has kept the world afloat for nearly a decade after the last recession. What comes next will be very different from what we’ve experienced so far. In a recent interview with Dutch newspaper De Volkskrant, billionaire investor Warren Buffett warned that “the next recession will come sooner than people expect” and will be more severe than in 2008 because monetary policy has backed up against its limits. Markets remain overpriced, he said, and artificial stimulus won’t work for much longer. “We are sitting on a keg of dynamite that will explode sooner or later,” he said. This time, the recession is not because we are running into economical trouble, it is we are having too much wealth!
Why is the next recession coming?
The global economy is currently growing at the slowest rate in the last five years. A marked slowdown in the Chinese economy, heightened trade tensions, and uncertainty surrounding Brexit have dented global growth. This can be seen in weaker trade growth, declining corporate earnings, and a slowdown in global investment. The US economy, the world’s largest, is also facing headwinds. The recent stock market turmoil in China and the US-China trade war have only added to the picture. It is important to remember that the Chinese market was already grappling with a slowdown in economic growth and a real estate slowdown, both of which had a negative impact on the stock market. The US market, meanwhile, has been in the grips of a bear market for months, with the S&P 500 hovering at around the same level as it was back in October 2017. Worst, the US printed much money to cover the Pandemic downturn and to carry more debts that cannot be erased easily without possible economical contractions.
Record-high household debt and overvalued equity markets
Household debt in the US has surged to record highs. According to the Federal Reserve’s data, the ratio between household debt and income has increased to a record high of 6.8. This is far higher than the average over the past three decades of 5.5. Household debt has been rising in the wake of the financial crisis, as the Federal Reserve kept interest rates low. Meanwhile, household income has been falling since the 2008 financial crisis, falling from $51,971 in 2007 to $44,749 in 2017, according to the Bureau of Labor Statistics. Amid this backdrop, equity valuations are at their highest ever. The S&P 500’s price-to-earnings ratio (PE) is currently at 22.6, well above its long-term average of 16.5. This means that the stock market is trading at a premium, as investors are willing to pay more for each dollar of earnings. However, when an asset is trading at a premium, it is more likely to face a correction or a slump.
Central banks have run out of options
Central banks have maintained the fragile global economy on life support through years of ultra-loose monetary policy. They slashed interest rates to record lows and pumped trillions of dollars into equities, real estate, and other assets through asset purchase programs like quantitative easing (QE). But now, after nearly a decade of quantitative easing, central banks are cutting back on their support for the economy. The Federal Reserve has already ended its QE program. The European Central Bank (ECB) and the Bank of Japan (BoJ) are winding down their stimulus programs. The BoJ has ended its QE program, and the ECB has hinted at an end to its asset purchase program. Other central banks are expected to follow suit in the next few years. Infinity QE is not a solution but a problem to create down the road. The Fed needs to control the consequence of the QE – inflation and avoid the hike in the unemployment rate – the recession is unlikely successful. While huge debts drag the Fed’s foot to proceed more aggressive Quantitative Tightening (QT) gives the Fed no choices but to put everyone into recession and possible QE again to pump up the economy.
Protection against recession: don’t rely too heavily on equities or bonds
While equities and bonds have generally performed well in the face of global financial crises, they are risky assets that are subject to extreme volatility and can fall significantly in a recession. You can reduce your exposure to equities by investing in equities in different regions and industries so that you are not too heavily concentrated in one sector. This will reduce the damage to your portfolio in the event that one sector suffers a significant decline in value. You can also diversify your equity holdings by choosing low-cost Exchange-traded funds (ETFs) that track different indices, like the S&B 500, MSCI EAFE, FTSE 100, and others. Bonds provide a steady and reliable income, but you must choose your bonds carefully; ignore the allure of high-yield corporate bonds and invest in government bonds instead. If you are looking for an investment that offers higher yields, then consider real estate investment trusts (REITs) or stocks in high-yield companies, which have a higher risk profile. Of course, there are always cases that you cannot predict.
Recession-proof portfolio: invest in cash, gold, and high-quality businesses
A recession-proof portfolio should be flexible and dynamic, allowing you to shift between different asset classes depending on market conditions. It must be able to deliver returns regardless of economic conditions and must not be heavily dependent on interest rates, equities, or bonds. The following are some of the best ways to build a recession-proof portfolio: Invest in cash: If you want to invest in cash, you can buy short-term Treasury bills, money market funds, or invest in a high-yield online savings account. Invest in gold: While gold is not a useful asset in all economic conditions, it is an ideal asset to own when the economy is heading towards a recession. Invest in high-quality businesses: You can choose to buy the shares of a company that you believe will perform well even in a recession. However, you must select your investments carefully, as stocks tend to lose value in a recession.
Recession-proof portfolio: invest in cryptocurrency
Another way to weather recession is to dive into cryptocurrency. Of course, you should bear in mind that crypto is a lotto ticket to the future. A gamble to prevent the worst-case scenario. You should not yolo your hard-earned money but put a small fraction of your money into buying and forget about it. Also, there is no perfect recession-proof portfolio but to trade off the short-term risk for a long-term gain under your bear risk and mental health. The key here is not to beat up the recession but to explore a potential opportunity.
And do not waste your time following the trend:
A recession is a natural part of the business cycle and inevitable in the life of any economy. It is important to remember that recessions are not unusual and they are necessary for maintaining a healthy economy. A recession can affect everyone, no matter what their profession or industry. While there is no way to predict exactly when a recession will occur, it is important to prepare for one by setting aside savings and building up an emergency fund. With the right strategies and a little luck, you can weather the storm and come out stronger on the other side. Now that you know what a recession is and how to protect yourself from one, you can keep calm and be prepared for anything.