Anyone else starting to feel like the sh&% is about to hit the fan? Economically speaking of course. It’s crazy to think that you can throw money at just about anything and it’ll increase in value. Seriously, even JC Penney NYSE:JCP is up 12% this year as of this writing. Does anyone know anyone that still shops at JC Penney?! Don’t get me wrong, I’m all for the gains, and admittedly, I’m way too exposed to the equity markets, which is playing out well right now, but I’d be in trouble were the music to stop playing anytime soon. What’s even more confusing is that I can’t think of any reason for the markets to retract in a serious way, but it seems like we’re way overdue. Even if it just comes from investment managers taking some profits at what seems like the highest of market highs. Why aren’t they? My guess is they’ve seen their golf partners across the street get screwed in increasing numbers by doing so. 5 to 6 years ago, the big talk was of a “double-dip” recession, but it never came. But that didn’t stop fund managers from running scared, pulling money from equities and dumping it into a mix of gold, cash, and other assets typically thought to provide shelter in bad times. I’d venture a guess that a lot of those guys are working somewhere else now as their returns would look terrible compared to those that stayed in the game and weathered the verbal onslaught from those doing the opposite. Even if they just indexed all of the money that they managed, starting in 2012, they’d be up over 100%. Right now, signs are still looking pretty good for continued growth. The economy is still adding jobs (about 200,000 in January), savings rates are falling (probably not good for individuals, but it generally means that people are spending more and fueling the economy), and the Atlanta Fed, just a few days ago, raised its 1Q18 projection of economic growth to 5.4%, which would be the strongest single quarter since the last recession. But while all of this signals good things to come, let’s consider some of the things that could derail this momentum, and what we could do to get out of trouble should we find ourselves in an economic downturn sometime this year.
- The Fed – The Fed has a target federal funds rate of about 2%, which means that it would need to increase rates periodically throughout the year to get from the current 1.25% – 1.5%. While the Fed doesn’t technically control the federal funds rate, it can influence it via reserve requirements, the discount rate, and open market operations. If you think about an interest rate being the price to borrow money, by increasing the rate, the Fed is essentially increasing the price to borrow, making it more expensive for companies to get money for new projects, they then hire less, and so on. The ultimate result is that an increase in rates tends to slow the economy. If done too quickly, people could panic, sell off stocks, and save more. Without people spending, companies will produce less, hire less and the downward spiral begins. The fed is likely the biggest threat to the markets and economy today.
- Jobs/Wages – On Friday, the Labor Department reported that private sector wages increased 2.9% compared to the prior year, representing the largest such gain since 2009. Unemployment remained at about 4%, the lowest rate since 2000, and 200,000 jobs were created last month. While all great news, should any of these fail to maintain their strength going forward, reduced spending could ensue, hampering economic growth.
- Political Turmoil/World Events – North Korea, Trump, conflicts in the Middle East, terrorism… These speak for themselves, but any of these could reasonably lead to worldwide panic.
If it Happens…
The government’s lack of ability to step in and act should we find ourselves trapped in a downward spiral is what concerns me most. One of the most common responses to an economic slowdown is reducing interest rates. Using the same mechanisms outlined in the prior section, the Fed can manipulate the health of the economy. Lower rates, reduce reserve requirements, and voila! The economy is humming again – only we’ve already done this. In fact, interest rates are already so low that if the Fed were to signal that they were reducing rates again, it might not affect investor sentiment. Even worse, it may cause market declines since a decline in rates would signal that the Fed is losing faith in the economy’s ability to sustain itself.
Another lever that could have been pulled in a time of need is tax rates, both corporate and individual. Lower the amount that people have to pay in taxes and there’s a possibility that they’ll spend at least a portion of their tax savings. Of course, they could just hoard it all, which is especially likely if they feel financially threatened. But should they spend it, the economy should pick back up.
Similarly, reducing corporate tax rates frees up cash for companies to invest in projects that require employees, providing people with jobs, and so on. Again, the issue here is that we’ve already done this. Imagine the economy as the fire on your grill on the 4th of July. The actions we’ve taken so far are the equivalent of pouring the last bit of lighter fluid on the fire while its burning hottest, leaving none for when the flames go out and we need light the next batch of charcoal. There are some other things that could be done, but I think they’re less desirable. For instance, they could pull money from government-funded programs like SNAP, and use that money to provide a stimulus package in hopes that people spend the money, but that seems like a temporary fix. Theoretically, the Fed could try a negative interest rate policy but I think this would be unprecedented in the States. They could also further reduce taxes. Each of these actions has its own set of issues though. I’m sure that there are other alternatives, but I think we’d be in for a decent amount of trouble if the economy slows significantly.
What We Can Do Now
Often, the best time to prepare for bad moments is when you’re doing well – this is true of financial planning as well. Imagine waiting until you were let go from a job to realize that you needed to start building a rainy day fund… This is actually your best protection against economic downturns, and you can view my guidance as to how to manage one in a previous article. Rainy day funds provide a sense of strength and can help relieve anxiety when the financial seas become turbulent, providing extra time to find that next job, cover an unexpected expense, and even be an aggressive investor. Image having an overfunded emergency account when stocks were at all-time lows, and houses were being sold for pennies on the dollar!
Another good idea is to consider the diversification of your portfolio. Not only within one asset class, like stocks, but among asset classes as well. Consider buying real estate assets, in addition to making sure that you aren’t overexposed to any single sector in the stock markets. Consider holding cash as well. You can invest it risk-free, in highly liquid accounts, although you will earn very little interest if you do so. The upside is that you won’t lose any money either.
Finally, find a way to track your net worth, and not just your bank accounts. So far, Personal Capital has been the best way for me to track my funds. It’s accurate, user-friendly, and provides detailed charts and alerts to help you reach your financial goals. Most importantly, it’s free – because who wants to pay to save money. Mint is another good option, but it can show delayed results from time to time making it less accurate, and it fails to offer all of the free tools Personal Capital does.
Hopefully, I’m incorrect and the economy keeps booming! But in the case I’m right, you should be better prepared to protect yourself and even take advantage of any unique investment opportunities that present themselves.
What are your thoughts on the overall health of the economy? Are we headed for doom, or will the good times keep rolling? Let us know in the comments below.