Republished courtesy of the National Post
by Tom Bradley
I’ve been doing a lot of client reviews lately and the ‘R’ word has come up in every one. I’m referring to the next recession.
Sometimes it is framed as a question, but often it’s delivered as a statement of fact — i.e. we’re heading into recession. I’m sympathetic to both because the current cycle has been a long one and there are increasing signs of a slowdown.
But whether it’s next week, next year or beyond, we need to remember that a recession’s relationship to investing is a complicated one. Here’s what I mean.
When, not if
First, we will have a recession. Predicting when, however, is difficult, if not impossible.
For instance, I’ve been anticipating a slowdown for a few years, but non-stop stimulation by governments and central banks has kept the economy growing. How long they can keep using one credit card to pay off another is anyone’s guess, but we shouldn’t underestimate their resolve. Even if near-zero interest rates are losing their impact, there’s still room for an increase in government spending.
When asked, I tell clients that we’ll know we’re in recession when it’s almost over.
What about Canada?
The Canadian economy is interesting because we’re experiencing a job boom at a time when many economic indicators are screaming bust. Consumer and business spending are extremely weak. Debt servicing is high, even with low interest rates. And our household savings rate is hovering around two per cent (compared to seven to eight per cent in the U.S.).
But while a made-in-Canada recession may affect your family and lifestyle, it will have limited impact on your portfolio, at least if you’re broadly diversified across industries and geographies.
What happens here will barely be felt by foreign-based and globally focused Canadian companies.
A domestic slowdown’s biggest impact will be felt on the fixed-income side of your portfolio. When growth goes negative, our already low (dare I say, recession-like) interest rates will likely fall further. This will push prices on high-quality bonds higher and help stabilize your overall returns.
Of course, if your portfolio is made up mostly of companies dependent on the Canadian consumer such as banks, REITs, retailers and telecommunications companies, you’ll feel a slowdown more.
I don’t mean to sound cavalier about the Canadian economy, but its mind share will be far greater than its investment impact.
On the other hand, a severe global slowdown (with or without Canada) will move the dial on your portfolio. Corporate profits will decline (into negative territory for some companies) and the associated market psychology will push valuations down. It’s a double whammy — lower multiples on lower earnings.
Before you head for cover, however, consider that the International Monetary Fund (IMF) just lowered its world growth estimate for 2020 to 3.4 per cent and talked of a “synchronized slowdown.” This is the lowest level of GDP growth since 2008 but is nowhere near negative (we’d kill for three per cent growth in North America).
It may be that a synchronized slowdown will trigger a series of rolling recessions. Germany is now flirting with negative growth, the U.K. is going through a self-inflicted slowdown, China is as close as it gets to recession, and yet, the world’s largest economy south of our border, while slowing, is showing no signs of cracking.
Did I say it’s complicated?
Whether it’s a rolling recession or the big one, we shouldn’t forget that the linkage between the economy and your portfolio is a sloppy one. There should be no expectation of precision, which makes recession proofing tricky. We don’t know when it’s coming, what will be affected the most, and the clincher, how well it was anticipated.
On the latter point, a veteran portfolio manager said to me recently, “This will be the most anticipated downturn in history.” In other words, Canadian investors aren’t the only ones that are worried about the ‘R’ word.
To me, recession proofing means being mentally prepared for it (when, not if), sticking to the plan (you don’t get the up without absorbing some down) and recognizing that downturns cleanse the system of speculation, excess leverage and risky behaviour, all of which curb future returns. And remember, all bull markets are hatched when times are tough.
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