The world remains an uncertain place. Although in North America we are in a period of calm with relatively strong employment there are some signs that things may be getting worse. Retail sales are falling at a pace not seen since 2009. The struggle appears to be worldwide. Americans are struggling to make their loan payments. Even car payment defaults are on the rise, and this is one of the most necessary items in most American’s lives, usually needed as transportation for work. It has been reported that seven million car loans were more than 90 days past due in the fourth quarter of last year. That is more than during the Great Recession of 2008-9 when unemployment was twice as high. This largely may reflect the fact that car loans have been given to those who never should have gotten one.
Increased signs of weaker economic activity are why Central Banks are starting to “back peddle” from the idea of additional rate increases. In the opinion of some economists, they may have already gone too far and the economy could soon falter as a result of past hikes. Nevertheless, at least for now, not all news is bad. Despite the fact that household debt is at an all time high, as a percentage of income interest payments are at an all time low. As long as people keep their jobs and interest rates do not rise to the point where defaults become prevalent, things will be ok. But it’s important to remain vigilant given things are starting to fray at the edges. Then what will matter is to be prepared.
The truly best way to be prepared is by means of a higher personal savings rate. A decade of zero interest rate policies has discouraged everyone from saving their money for the future. The government shutdown in the US revealed just how many people live day to day, with no cushion in the bank for a single missed paycheque. Generally it is believed that one should always have enough cash in the bank to cover at least six months worth of expenses. It is not wise to depend on safety nets such as unemployment insurance or government pension funds. As we well know from following politics globally, nothing is guaranteed by those in government that claim to have the people’s best interests at heart. It is well known, for example, that Social Security and Medicare in the US does not have enough funds to meet all their liabilities, so for those that are counting on it and did not save enough this may come as a very unwelcome surprise. Likewise in Canada, if you have nothing saved and expect to live off your government pension, you will be living a pretty meager life. The point is always be prepared for the worst, as that is what ultimately will give you the least amount of stress financially.
Although we have not seen a recession now for a long time, it is important to note that economic expansions do not die of old age. The issue is that when times are good, inevitably excesses build up which require correcting and things derail as a result. When things look like they cannot possibly get better, it is time to start planning for when things start getting worse. If you plan ahead you can profit from any misfortune. If you don’t, you will be part of that misfortune.
The global economy has had a good ten year growth run. It appears we may now be entering a period of slower growth. China, the great global engine of growth, is decelerating at a rapid pace with cars sold plummeting almost 17% in January. In fact 2018 marked the first annual fall in car sales in China since the early 1990s. Likewise European car registrations dropped almost 5% year over year with sales declining across the region’s largest markets. These are strong signals that demand may have peaked everywhere and just how sensitive the global economy has become to even modest interest rate increases.
It is therefore probably wise to start anticipating a recession at some point in the near future. This is certainly what central banks are indicating by taking the decision to halt rate increases. Nevertheless, even when cash is king, that does not mean it is necessarily time to panic. Economic cycles are normal. Investment portfolios ebb and flow with those cycles. Just because profit growth slows down, it does not mean you need to sell perfectly good businesses. However, it is imperative that when investing your hard earned savings, you are aware of all the pitfalls and maintain a strong focus on the end goal. When it comes to investing in equity and bond markets, it is all about owning the very best companies with the strongest competitive advantages, as they are the most likely to make it to the other side. Recessions do bring more bankruptcies, and those businesses that go into slower cycles with too much debt live to regret it.
So how to prepare for a downturn? The best and safest option is always to hold on to some cash, not just in your personal bank accounts but also in your investment accounts. Only then will you be able to profit when the price of everything goes down, because downturns tend to take no prisoners and take everything down. When people have to liquidate they sell what they can, not just what they want to sell (which usually is the worst stuff that nobody is willing to buy at any price). This then becomes the opportunity to buy some of the best companies at discounted prices. This past December offered that opportunity in a few names for those brave enough to step in. The price recoveries are often sharp and dramatic when they happen so seizing opportunities at the bottom makes good sense.
Another way is to concentrate your positions in stable dividend paying stocks, as long as their dividends are safe and their earnings are expected to be sustained during the downturn. Because dividends offset some of the losses in the overall market, these stocks tend to fall less during corrections. The key word is “stable”. Not all dividends are equal. There are companies that continue to sell their services in the worst of times because they offer services/goods people cannot do without. If they have a strong balance sheet and have a better product than their competitors their dividends will be safe and could even continue to grow in the worst of times. If they don’t, then all bets are off.
To conclude, the most important thing to remember is to not panic in downturns but make sure you go into them prepared. The landscape is littered with losses by people who buy stocks when markets are up and then panic when markets go down and sell at the worst possible time. That is the surest way to lose money over the long term.
It is essential to know what you own, believe in it, and get very excited when it starts trading at a discount. That is what good positive long term returns are made of. Owning index funds are convenient but you own the good with the bad. Knowledge is power. Know what you own. Invest only in the best balance sheets and income statements and business models with strong moats and you will always come out ahead over any decade, regardless of political fights, recessions, market corrections, and any other hurdle that must be overcome along the way. What matters is the long game and staying the course. Always be prepared for the worst and the benefits will follow.
The Summerhill Team