About the Series…
When people discuss money management, they often focus on tactics. Sometimes, the conversation elevates to strategy, but what’s often overlooked is a broader perspective on how to enhance our thinking and decision-making skills.
This series aims to incorporate first principles thinking into discussions about money. Welcome to the first post!
In this edition of First Principles—where we redefine FIRE as Financial Psychology, Investing, Real Estate, and Entrepreneurship—we’ll address the pressing question: Are we on the brink of a recession?
Financial Psychology: Are We in a Recession?
Short answer: Possibly; it might even lean towards “probably.”
A recession is typically defined as two consecutive quarters of negative economic growth, as measured by GDP. Importantly, recessions reflect the economic environment, not the stock market, which is a distinction we’ll revisit shortly.
By its very nature, a recession becomes apparent only after two quarters of negative growth have passed, which means we could already be in one or facing one soon.
Why Now?
What’s contributing to this potential recession? The main culprit is inflation.
As many are aware, the Federal Reserve has been increasing interest rates, with five rate hikes occurring in 2022 alone.
The Fed has a dual mandate: to manage inflation and mitigate recession risks. This duality exists because controlling inflation often comes with the risk of triggering a recession.
Why is that?
To combat inflation, the Fed must make borrowing more expensive. As access to affordable credit diminishes, personal and corporate spending tends to decrease, potentially leading to consecutive quarters of negative growth—a recession.
What Does This Mean for You?
Recessions have varying characteristics:
- Severity
- Duration
- Frequency
It’s easy to assume that any recession will mirror the Great Recession of 2008. This tendency is driven by cognitive biases:
- Recency bias: Overvaluing recent events and their likelihood of recurrence.
- Salience bias: Focusing on extraordinary events while ignoring the mundane.
- Availability bias: Thinking that easily recalled examples are more significant than they are.
The Great Recession was notable for being severe and prolonged, affecting millions by resulting in job and housing loss.
However, will every recession conform to this experience?
Looking at 2022, there are several factors distinguishing this period:
- Low Unemployment: As of May 2022, unemployment remains low at 3.6%. Despite headlines about layoffs, the overall labor market remains tight.
- Rising Housing Prices: Home values continue to increase despite higher interest rates, fueled by supply-demand imbalances and elevated construction material costs.
- Strong Consumer Spending: Spending remains robust, particularly in leisure sectors like travel and dining, indicating consumer confidence despite inflationary pressures.
What’s the Implication?
Whether we are already in a recession or are about to enter one, it may be more “on-paper” than a dire reality for the average middle-class worker. If unemployment stays low, consumer spending holds firm, and inflation is brought under control, this recession could be lengthy yet mild.
It’s essential to resist letting cognitive biases distort our perceptions. Not every recession will mirror the 2008 crisis.
SPOTLIGHT ON…
If you’ve been keen to enter the real estate market but hesitated, there’s still time to uncover valuable deals. Even amidst market fluctuations, opportunities exist if you know where to look.
Enrollment for my comprehensive real estate investing course, “Your First Rental Property,” will soon open for the only time this year. If you’re interested in timely notifications, join the VIP list.
Investing: Understanding Recessions and the Stock Market
Recessions indicate economic downturns, not just stock price declines. As defined, a recession involves two consecutive quarters of declining GDP.
Investor reactions can vary widely. Growth investors often retreat during downturns due to anticipated lower profits, leading to stock sell-offs. Conversely, value investors may seize opportunities to buy undervalued stocks they believe will thrive in the recovery.
Currently, inventory levels are fluctuating: stocks are volatile, cryptocurrencies are down, and bonds appear less appealing.
This is predictable given the economic trends following the pandemic, which saw $10 trillion injected into the economy. This influx led to a rapid rise in asset prices.
With liquidity now tightening, asset values could fluctuate before stabilizing at new, fundamentally backed valuations.
What This Means for You
Expect the landscape to remain volatile throughout 2022 and potentially into 2023 as markets adjust. Stock, crypto, and bond prices may experience wide swings as investors seek clarity on the “new normal.”
These periods often result in a market “cleaning house,” where poorly managed companies face challenges, making way for stronger competitors.
Historically, many successful companies have been launched during recessions, and the next economic downturn could foster similar opportunities.
Real Estate Insights
We have developed an extensive email series diving into recession and inflation and their potential impacts on the housing market. While too detailed to cover here, be sure to sign up for insights tailored to those considering real estate investments.
Entrepreneurship Takeaways
One noteworthy trend to watch in the coming months is the unemployment rate. At present, many businesses are struggling to find talent due to a competitive labor market, which makes recruiting particularly challenging for small businesses.
If the labor market loosens, it may become easier for small businesses and real estate investors to hire talented workers, particularly contractors.
The tight labor market creates ripe conditions for entrepreneurial opportunities, as talented professionals often seek new jobs during economic shifts.
Thank you for joining this edition of First Principles. I look forward to continuing this discussion in the next post!
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See you soon!
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