An Urgent Warning For Investors | The Coming Recession

What's up guys, it's Graham here. So, I think it's about time that we address a topic that I'm sure a lot of us have considered, and that would be an upcoming recession. After all, in the last few weeks, the yield curve began to flatten as an early recession warning. Inflation is now at a 40-year high; buying conditions are the worst they've been since the 1970s. Goldman Sachs increased the risk of a U.S. recession to 35 percent, with rising energy prices. And just recently, a man was sentenced to three years in federal prison for using COVID relief funds to buy a Charizard card.

Okay, that last one had nothing to do with the recession, but I figured we should lighten the mood up a little bit anyway. With all of these concerns, we should talk about what's going on, the potential impact for not only you but also the entire economy, and why the search term "recession" has just increased a hundred percent—a trend which so far has preceded both the 2008 mortgage crisis and the 2020 shutdown. All of that and more in this episode.

The first person to correctly guess how many times I say the word "recession" will get the pinned comment on the video. But before we start, if you appreciate all the work that goes into making a video like this, it does help me out tremendously if you hit the like button or subscribe if you haven't done that already.

Alright, so first, in order to understand how to best prepare for something like this, we need to talk about what a recession really is because even though it's easy to think the stock market's gonna crash, everyone's gonna lose their jobs, and energy prices are so unaffordable, the reality is a recession doesn’t always leave people left over with nothing, and they aren't always catastrophically damaging.

See, technically, a recession is defined as two consecutive quarters of declining GDP, which in simple terms means that less money is spent, our economy contracts, and news outlets could get more clicks with a spooky headline. But since GDP isn't always a true indication of the overall economy, the National Bureau of Economic Research updated their definition to include a significant decline in economic activity that can last for a few months to more than a year, and that is usually accompanied by lower employment, production, and sales, as monitored on a monthly basis rather than quarterly.

Now, in terms of how common this is and just how bad things can really get, since the 1940s, we've had 12 recessions, the longest lasting 18 months, the shortest being two months during the COVID shutdown. Since 1900, the average recession tends to last about 10 months with usually pretty devastating effects. For example, the Great Recession from 2007 to 2009 was sparked by the collapse of the housing bubble, which sent the stock market tumbling 40 percent. Several large banks collapsed, and that required an 800 billion dollar stimulus package to recover.

Before that, we saw the dot-com bubble, where the NASDAQ lost 75 percent of its value. The U.S. grappled with the September 11th attacks, and the collapse of Enron and Swissair all occurred around the exact same time. We also had the Gulf War recession in 1990, when the Federal Reserve was raising interest rates to help bring down inflation, but that slowed down the economy, which took an even bigger hit when Iraq invaded Kuwait and caused oil prices to skyrocket.

Now, the other common factors of past recessions include rising energy or oil prices, rising interest rates, or changes in spending after a war. Sounds familiar, right? It's also, unfortunately, generally accompanied by a rather abrupt sell-off in the stock market.

Although in terms of whether or not we could see a recession in the near future, here's what we need to be made aware of. The first is what's known as an inverted yield curve. This occurs when the two-year treasury rate pays a higher amount than the 10-year rate, thereby inverting and signaling that investors see more risk in investing in the short term than they do in the long term.

Hopefully that made sense, but even if it doesn't, all you need to know is that when this happens, it's used as an indicator that economic growth is expected to slow down. Even if we look back in history, an inverted yield curve has correctly signaled nine recessions since 1955, with only one false positive in the 1960s where there was an economic slowdown but no official recession.

So, when it comes to what's happening today, we're currently seeing what's called a flattening yield curve, which means the two and ten year treasuries are paying almost the exact same amount, while the flattening is the most extreme it's been since 2011. Overall, this is something just to be made aware of, and our yield curve has yet to invert. But this is just the beginning because on top of that, we also have increasing energy costs.

As Goldman Sachs explained, rising commodity prices will likely result in a drag on consumer spending, as households—and lower-income households in particular—are forced to spend a larger share of their income on food and gas. On top of that, rising interest rates make it more expensive for consumers and businesses to get access to capital, and all of that results in two words: less spending.

The reason why high energy prices are so correlated to a recession is that a commodity like oil is used in almost every aspect of our day-to-day lives. All of a sudden, when that cost goes up, the more expensive it is to manufacture the item, the more expensive it is to ship, the more expensive it is to purchase, the more expensive it is to hit your home, travel, or drive a car. All of that results in less money being spent.

That also plays a large part with inflation expectations, which might prompt the Federal Reserve to raise interest rates faster than expected, which might cause businesses to cut back, investors to wait on the sidelines, and everything to go to poop. Although third, we have slowing corporate profits. See, when companies report their earnings—as they do every quarter—they typically issue guidance to what they expect for the future.

This gives shareholders a better understanding of upcoming earnings, sales reports, projections, and market conditions. However, as MarketWatch pointed out, the ratio between negative and positive guidance spiked above average for the first time since prior to the pandemic. An analyst at Morgan Stanley warned that last week's tactical rally in equities will likely run out of momentum in March, as the Fed begins to tighten and the earnings picture deteriorates.

He cautions that companies will have a tougher time meeting earnings expectations than investors think, and as a result, less consumer spending, less growth, and higher prices could result in declining GDP, leading us to that recession signal that everyone is looking for.

Although in terms of what this means for the stock market and how you could use this information to make you money, here's what you need to know. Alright, so in terms of how a recession can impact the stock market, here's where things get really interesting. From 1869 to 2018, there have been a total of 16 recessions which had positive stock market returns. In fact, of those positive returns, the market went up an average of 9.8 percent during a time the GDP declined by 3.

In other words, out of 30 recessions, the stock market had almost no correlation whatsoever to stock values. To take that a step further, another study found that the correlation between GDP growth and stock market values was almost nothing at 0.05 percent. On average, the stock market tends to peak six months before the start of a recession, and that is where we get into some of the bad news.

Throughout every single prior recession since 1945, the stock market has at some point seen a sell-off, with an average drawdown coming in at a whopping 29.2 percent. However, the good news is that even though there can be an abrupt sell-off, by the time the recession is over, the market actually recovers and has posted an average profit of 1.7 percent, with an average gain of 15.3 percent the following one year. This means investing during a recession could be one of the most profitable times to invest.

Not to mention, in the three years following every single recession we have ever had, the market was a hundred percent in the green. However, as Ben Carlson pointed out, it's not as easy as just thinking, "Oh perfect, I'll just invest during a recession, then it'll be easy," because, as he mentions, you won't know you're in a recession until it's too late.

Since technically a recession is two consecutive quarters of declining GDP, we could be in a recession right now but not officially know it until much later. For example, the Great Recession that began in December of 2007 wasn't officially discovered until December of 2008, in which it was almost completely over. The recession before that began in March of 2001, but they didn't officially call it a recession until November of that year.

And that consistently continues with about a six to twelve month delay in between the time a recession starts and it's officially called. In this case, the market found that most of the time, the markets saw peak pain six months prior to a recession because for the most part, the stock market tends to be forward-thinking.

If anything, Bloomberg notes that a bear market is a better predictor of a recession than a recession being a better predictor of a bear market. Although even though a recession could very well be happening right now or in the near future, the worst worry is the term that most people are completely unaware of, and that would be stagflation.

For those unaware, stagflation refers to a time of high inflation, high unemployment, and slow economic growth, of which is becoming a lot more of a concern lately, with Google Trends showing its largest search volume ever since they started tracking in 2004.

Now, even though this is not a term that most people hear about, it last happened in the 1970s when oil prices skyrocketed, inflation was out of control, interest rates were unstable, and companies chose to hold their prices steady while simultaneously laying off their workers. In this case, prices went up, inflation went up, and the economy went down, and it took a massive increase in interest rates to get inflation under control.

The problem with this type of situation is that the solution for high inflation or low growth usually makes the other one worse. For example, raising interest rates fights inflation, but it hurts growth, and lowering rates helps growth but it hurts inflation.

See, the problem, however, as of now, it doesn't look like we're approaching a point of no return, and others argue that with the U.S. reducing its reliance on other nations, that should in theory no longer put downward pressure on U.S. prices and wages, effectively making stagflation unlikely to happen.

Overall, though, in terms of analyzing the commonalities between previous recessions and what we're seeing today, we could see that the five major changes usually tend to be: One, sudden economic shock, like the oil crisis of 1970 or the COVID crisis of 2020. Two, excessive debt, which includes the housing crisis of 2007. Three, asset bubbles, like the 2001 dot-com crash. Fourth, inflation, which forces the Federal Reserve to raise interest rates and tighten financial growth. And five, deflation caused by a lack of demand for goods and services, which usually results in higher unemployment.

As for where we are in the cycle, we do have sudden economic shock with the Russian-Ukraine invasion, we have the highest inflation that we've seen in 40 years, and some argue that we've seen asset bubbles forming throughout some of the more speculative parts of the stock market.

Although even though three of those five boxes are checked, the reality is there's no chance of predicting a recession based on market returns, and most economists have no idea we're even in a recession until it's much, much later. That's why based on every recession we have ever seen in the past, the best course of action is to stay invested.

And if we are in a recession, it's even better to invest when times are bad. Just expect that stock market volatility is going to be a lot more common. It's always a good idea to focus on staying employed and understand that no recession has ever lasted more than 18 months, so there's always going to be light at the end of the tunnel.

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