Why Recessions May Be Inevitable - YouTube

The fear of recession is mounting in the United

States.

Where do you peg the probability of a recession?

Right now? Let's say by year end, I'd say about 50/50.

It's pretty close.

In June 2022, the World Bank slashed its global growth

forecast to 2.9%, warning that several countries could

fall into recession.

I think there's a lot of fear just around how it's

going to play out, how long it's going to be, and how

deep it's going to be.

And it hurts a lot of people.

I think the pain tends to be kind of concentrated in

the victims of the recession. But none of us

can be completely sure that we or our families are not

going to be among those victims.

Recessions also often impact the valuation of other asset

classes, like the value of your house or the value of

your car.

And last but not least, it's that really most

important one, that increase in the unemployment

rate, where people really fear that they could lose a

job and thus lose income.

I do believe recessions are really inevitable.

I believe that the economic cycle exists.

But some believe that this isn't all bad news.

Some investors, they look at recessions as opportunities.

This is an opportunity to buy this asset that's now on

sale and now it's at fair value.

I think it's really important to just understand

the mechanics because I think when you do, knowledge

is power, information is power, and then you can

start to be able to seize the moment.

So why do recessions happen and are they an inevitable

part of the American economy?

The National Bureau of Economic Research defines a

recession as a significant decline in economic activity

that's spread across the economy and lasts more than

a few months. It's been synonymous with major

economic pain felt by businesses and consumers

alike. The Congressional Research Service cites three

main causes of a recession.

The first is an overheated economy.

When economists talk about the economy overheating,

they mean that demand in the economy is growing

faster than the ability of the supply side of the

economy to satisfy it.

And that can be because we just can't produce enough

stuff, or it can be because we don't have enough

workers.

A hot spike in inflation alongside a dip in the

unemployment rate could signal that the economy may

be overheating. Every recession but one since

World War II has seen an inflation hike right before

the start of the downturn.

And nearly every recession since World War II saw the

unemployment rate fall to 5% or lower.

When unemployment gets really low, it means that

there's not really very many available workers for

firms to hire.

And if firms can't find workers to hire, then they

have to start bidding up wages. As they start paying

people more, people have more income with which to

buy goods and services.

More income buying goods and services tends to push

up the prices of goods and services. So you get a

positive feedback between wages moving higher, pushes

prices higher, pushes wages higher, pushes prices

higher. And if the Federal Reserve didn't intervene by

inducing a recession and raising interest rates, that

spiral would get stronger and stronger and stronger.

And eventually you'd have inflation running away and

really getting out of control.

Asset bubbles can be another direct cause.

The recession of 2001 was primarily caused by the

dot-com bubble burst of 2000, while the Great

Recession occurred just after the crash of the

housing market.

Asset prices, whether they're stock prices or

house prices, go up a lot, and they exceed the

fundamentals, and then suddenly they come down

abruptly. That has a big negative effect on the

economy, particularly if people have borrowed to buy

those assets.

When that happens, people find out that they're not as

wealthy as they thought that they were.

And when you find out that you're not as wealthy as you

thought that you were, you cut back on your spending.

And as you cut back on your spending, that decreases

demand in the economy, and it slows the economy down,

and then enough of it can cause a recession.

In other times, recessions are caused by unpredictable

events that lead to severe disruptions.

Economists call these events black swans.

These are the things that, unfortunately, we cannot

manage. You cannot control geopolitical events.

You cannot control COVID-19.

But when they do happen, usually they're fast and

furious and have an immediate impact.

And that's what drove us into a very quick recession

throughout COVID and others that we've seen through the

course of time.

The U.S. has experienced at least 30 recessions

throughout history, dating back as early as 1857.

They may have become an inevitable part of the

economic cycle that fluctuates between periods

of expansion and contraction.

History teaches us that recessions are inevitable.

I do think recessions are part of our business cycle.

Do I believe that they're completely inevitable in a

capitalistic society?

Partly. There's so many events and external factors

that contribute to recessions, such as supply

shocks, demand shocks, geopolitical issues that

come about.

It's part of human psychology to get too

excited about things. And when you get too excited

about things, you ultimately have asset

bubbles and those ultimately lead to

recessions. It's also part of human nature that people

will continue expanding their firms and businesses

as long as the economy is good.

And as long as that keeps happening, you'll eventually

overheat, which eventually will lead to a recession.

Nonetheless, certain measures can be taken to

make recessions less likely .

As the nation's authority on monetary policies, the

Federal Reserve plays a critical role in managing

recessions.

With the right monetary policies, the Fed can

prevent a recession.

It's just very difficult to do so.

There are two things that the Fed can do to avoid a

recession. One is to steer the economy so we don't get

so much inflation that they have to slam on the brakes.

The second is to pay close attention to the financial

system so we don't have a repeat like the 2007, 2008

and 2009 recession, which was caused by too much

lending, too many mortgages, and too much

careless securitization on the part of Wall Street.

The Fed has often attempted to avoid a recession by

engineering what's known as a soft landing.

This is where precise interest rate hikes are used

to curb inflation without pushing the economy into

recession. But a successful soft landing is extremely

rare, arguably achieved just once, in 1994.

So what they're trying to do is raise rates enough so

demand slows.

So it's really a tough needle that they're trying

to thread to get our economy in equilibrium.

Now the question is, is there an amount of pressure

that they can apply onto the breaks that's enough to

control inflation, but not enough to crash the economy

? And the truth is that that's really, really

difficult to get into that really, really narrow zone.

It's the difference between trying to land an airplane

in a really wide, spacious, open field versus trying to

land an airplane on a very, very narrow piece of land

with rocks and water on either side.

Some experts argue that policies have a clear

limitation on what they can achieve against an impending

downturn.

Policy tends to operate with long lags.

I also think that increasingly we live in a

global economy where the cross-currents that are

impacting the economic dynamics are very complex.

These are dynamics that the Fed doesn't have tools to

address. And so, you know, to a certain extent, we do

think that policymakers have certainly developed

more tools to fight recessions, but we don't

think that you can rely on policymakers to prevent

recessions.

There are several early signs of recession that

investors look out for.

One tool that's commonly cited is the yield curve,

right? The yield curve inversion.

When the yield curve tends to invert, it means that

people expect that the bond market expects interest

rates to be higher in the short term than it does in

the long term. That's because the Federal Reserve

hikes rates to control inflation, and then after

inflation is controlled, it cuts interest rates back

down. So if you see that the market expects high

interest rates in the short term and low interest rates

in the long term, that's indicative that a recession

is coming, followed by an interest rate cutting cycle.

A lot of people look at some of the manufacturing indices

like the ISM Manufacturing Index.

When it tends to be above 50, that means that the

economy is expanding.

But when the ISM starts decelerating and approaches

50, a lot of people say, okay, the manufacturing side

of the economy is going to contract, that that could be

a recession indicator.

The third recession indicator that a lot of

people look at is consumer confidence and suggest that,

well, if consumer sentiment and consumer confidence goes

negative, that means consumers are going to pull

in, take the credit cards away, and not spend.

And that could cause a contraction in the economy.

A diverse portfolio can often provide the best

defense.

Diversify your holdings of assets to make sure that

you're including not only growth stocks, but more

value stocks and more defensive stocks.

Like health care, like the utilities market.

These are the companies that could manage through

this process a little more effectively than some of the

hypergrowth firms that are leveraging the credit market

more so than a company with a ton of free cash flow and

really strong balance sheets. And that's why I

think there can be some value in recessions, not too

deep and not too long, but in scenarios where we are

overheating, assets have gotten way out of whack, and

we need to get to a point where they get back to fair

value.

It also creates opportunities to be a stock

picker. It's very hard to buy stocks in a bull market,

but very often recessions and the bear markets that

come with it create brief opportunities to really

reload your portfolio, to buy the stocks that you've

wanted to own, essentially at sale prices.

But whether recessions are actually good for the

economy remains widely debated.

Look, recessions are very healthy things for the

economy because ultimately recessions flush out

excesses. So you think about it, when we have a

recession, it reduces whatever extreme bubbles may

have built up.

I think that's ridiculous.

This notion that somehow we need to cleanse the system

and the recession is a cleansing thing.

It's like saying everybody should have a heart attack

once in a while because it'll make them eat better

and exercise more.

It's just not true.

You know, recessions cause job loss and every job loss

is enormously unfortunate.

Becoming unemployed has enormously disrupted

people's lives. It causes enormous pain for families,

for households, for communities.

It's terrible.

For Americans, understanding how recession works can best

help them prepare for whatever may lie ahead.

Understanding the dynamics of a recession allows you to

potentially be more opportunistic and protective

of your wealth should these downturns happen.

Knowing that it may be coming can help you think

through decisions about: Do you want to buy a house or

do you want to rent?

Do you want to take a new job or do you want to maybe

wait because because the job market may soften up?

These are all things that, if you possess the knowledge

of the business cycle, can help you manage your

financial life in a much better way.