Economic indicators are flashing red these days. Interest rates have risen from lows that were thought to be impossible for generations. In the United States, short-term interest rates have gone up to the point where one year’s rates are higher than longer-term bond yields. This is because market participants expect future rates to drop and the economy to go into a downturn.
The fact that government, corporate, and individual debts are enormous compared to the size of the economy further darkens the outlook.
I prefer to use the term economic downturn instead of recession. Recession is a technical term defined by two consecutive quarters of negative GDP growth. It doesn’t matter, from a definitional point of view, if during that six-month period the economy had declined by 0.1 percent per quarter or 3.0 percent. Over the last year or more, average income has been increasing less than the price increases of the necessities of life. The average family is getting poorer. That, to my way of thinking, is an economic downturn.
Here are some of the lessons I have learned during hard times and good times from great financial writers, my parents who survived presently unimaginable hardship, and my own sometimes bitter experience.
The first thing one must do is have an attitude adjustment. The world is changing, which will continue at least for a while, and people’s pre-lockdown lives are gone. Everyone is getting a bit older and it’s time to become an adult. For most of us, spending on frivolities is no longer an option. A job is not a right won by incessant demands upon a society—it is an earned privilege. The majority of us need to say adieu to our old lives for a few years until this economic storm blows over.
The second thing needed is a “war chest.” Many people do not save. That may not be a problem in the short run during economic good times, but is disastrous and even dangerous during hard times. We have forgotten that the last few decades have not been tough by historic norms. Even during the lockdown, governments issued cash to everyone. It may be difficult for some who have low incomes, but I suggest saving 10 percent of after-tax income, more if possible, to build up funds. These funds will accrue quickly over the months and years and can be used in an emergency. If that emergency doesn’t occur, they can be used to accumulate cheap assets such as property or stocks. If the economy does falter, asset prices will get much cheaper and you can buy them cheap.
You can make sure you are not tempted to go into your fund or stop contributing by keeping the money in a separate account and, where possible, dealing with a financial institution that can automatically debit the account you get paid and pay bills in and credit your savings account. Anyone who does not live at a subsistence level can do this.
Try and approximate your monthly and weekly spending. Some expenses are fixed and non-discretionary, like rent or mortgage payments. Utilities are really non-discretionary. Turning off a light, freezing in winter, or broiling in summer is not an option, despite what our political and opinion leaders tell us.
Food and clothing are necessities of life, but you can save a lot of money in these areas as their costs are not fixed. According to the U.S. Bureau of Statistics, the average American ate 44 percent of their meals outside the home in 2018, which added up to US$3,459 a year. Cut down eating at restaurants and delivery services like Uber Eats. Bring your lunch from home. Only buy clothes you need and refrain from buying expensive brand products. If you’re scraping by but spending $200 on running shoes made by Uyghur slaves in China, you may want to reflect on your life choices.
Eat more meals at home, and accumulate a couple of months of non-perishable food. This will come in handy during natural disasters. I grew up in Montreal. One winter, the snow removal union went on strike and we got hit with a major snowfall. Fortunately, my parents kept our pantry and fridge stocked. Also, food prices could soar due to inflation and shortages. What costs $5 today could cost $10 by this summer. If things get really awful, which I doubt, you can help your friends and neighbours with some of your stock.
We are entering a new financial period. The “buy and hold” investment strategy will not work as well. Interest rates won’t likely be held artificially low by central bankers, so fixed-income investments are more attractive. A high weight in your investment portfolio is needed. Importantly, they reduce your downside risk. One crucial thing I have learned over four decades in fund management: the pain of losing money is far more intense than the joy of making it.
Over the past 30 years, the S&P had an average annual return of over 10 percent. That is very unlikely to repeat, especially if one adjusts for inflation. In the past, we have had long periods, in some cases decades, where returns averaged zero. If you bought stock in early October 1929, it took until about 1952 to break even. There were ups and downs during that period, but market timing is difficult.
If your equity exposure is high, reduce it. Also, concentrate on businesses that can continue to thrive in bad times, even if they are boring during booms. Utilities and consumer staples with strong balance sheets are preferred, especially if they have generous dividend yields. Real estate investment trusts (with the exception of office and shopping centres) with high cash flow and relatively low and rate debt will do well. They can also pass on inflation to their tenants. Stable, boring companies are more suitable in bad times than the “next big thing” and zombie companies who rely on access to cheap Wall Street capital. That cheap capital is disintegrating, and governments have too much debt themselves to bail out even their most beloved corporate contributors.
Surviving bad times is difficult, but it can be done. In fact, there are opportunities that did not exist during booms, and the self-discipline and frugality habits acquired will be of benefit for the rest of one’s life.
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