A recession is defined as a significant decrease in total economic activity in a particular area. It was traditionally defined as two consecutive quarters of economic contraction as assessed by GDP and monthly indicators like unemployment increases. This happens on average about every 3-and-a-quarter years. Unlike depression which causes massive unemployment of over 20% which causes the Dow Jones Industrial Average to fall by 30.57%. It took the US market 5 years to recover during that time.
“Oh No, a recession is here in 2022, and my stock portfolio is down over 20%.” is what every beginner investor will say when they look at the stock market for the first time. I don’t know about you, but I like it when a recession happens because it provides us investors a great buying opportunity to get more stocks at a discount. Therefore, Understanding and finding out how to prepare for a recession is a must for every investor. In this blog, you will learn to understand why a recession is a good thing and the positive effect it will bring to the economy.
What happens in a Recession
A recession happens in an economy when the overall GDP of a country declines and the US stock market drops more than 20%. As a result, unemployment rates climb as businesses lay off workers to cut expenses. Firms’ profit margins shrink on a microeconomic level. When revenue declines, whether, through sales or investment, businesses try to eliminate inefficient processes.
What causes the 2022 recession
Even though technically we are not in a recession yet because only Q1 2022 GDP was provided as of 31st May 2022. Q1 2022 shows a -1.4% GDP drop. Most analysts and investors have already prepared for the drop in GDP as there are many indicators that show worrying signs for the US economy. The reason investors were prepared for this sudden market downturn is irrational in stock growth relative to its business. One great example is Rivian at its all-time high was valued at $172.01 USD when there was less than 10 vehicle ever made. Compared to Tesla with a value of $1,052 USD producing 936,222 vehicles in 2021. If using Rivian valuation on Tesla, Tesla stock would be worth over 100 trillion dollars in market cap.
As Elon Musk said in one of his tweets “yes, but this is actually a good thing. It has been raining money on fools for too long. Some bankruptcies need to happen.”
Dumb money can create a lot of FOMO (Fear of missing out) in the stock market. This results in an ongoing cycle of stupid money flowing in the stock market, which is usually destroyed when the market crashes. Which we are currently seeing in the crypto market such as the Luna crashing to almost zero from a $40 billion dollar market cap.
The true value of a company will start to appear
As less money circulates in the stock market and businesses show slowing growth. The economy will enter into a bear market territory. Short-term investors and traders will take the opportunity to withdraw any gains they have made. As a recession will readjust companies back to their true value in the stock market.
Weeding out bad companies
There are many things to learn about bad companies and how you should not invest your money in these companies. During market downturns they they may go bankrupt or loses a lot of value. Bad companies having very similar issue that will cause investor to flee. These can be high debt that may not be able to pay off, high brunrate to draw business or terrible leader trying to make ends meet for the company.
Debt is a double-edged sword. Use it well and you can accelerate business growth by over twofold. Use it wrongly and it will destroy everything that you have built. Companies take on low interest rate debt to grow their business as using debt for company spending is considered non-taxable. During 2008 financial crisis, Lehman Brothers went bankrupt due to overleveraging. These caused over 6 million unemployment with a collateral loss of over $2 trillion.
As every business grew larger, they become less economically efficient. This means that many unnecessary roles or expenses will surface within the company that will affect the company. A great company must be able to be efficient enough during economic recessions. This is why retrenching workers is a necessary evil to keep the company afloat. Businesses will become more efficient during times that this and investors will notice the true value of a company.
Companies get better managed during recession period, whether they survive this transitional period is yet another question. If companies are able to well optimise their business and bring more value to the economy. Naturally investor will flock back to these kinds of stocks.
Rise of profitable small businesses
With a recession affecting large companies, small businesses are able to shine during these period. Entrepeneaur arises during such economic event to try fixing or better the world’s economy. Such companies that were born burning the global financial crisis are Instagram, AirBnB or Uber.
These small companies are able to grow exponentially faster as they have less risk and more experience working adult leaving after retrenchment. Expertise will flow from these larger companies to smaller one. These means that smaller companies are able to hire and obtain more skilled working to raise their businesses profitability.
Everything is on SALE!
A recession is a good thing for long-term investors. These investor understands nothing changes a company fundamental and such storms will past. By dollar-cost averaging into their favorite stock. It’s crazy how some investor flee during such times as such stocks should be viewed as discounted products. Yes the stock market is a weird place were investor do not go for discounted shopping spree.
When is it a good time to buy stocks?
Time in the market beats timing the market. If nothing is changed in a companies long term horizon, these are the company to stay invested in. During a recession period, getting more money to invest is one of the best financial decision as a long term investor. Warren Buffet once said he wished that there were many recession during his time so that we can take more of these opportunity on. That’s because tough times like these make company greater and if you span out during the long term, these recession would merely be a small dip in the broader market.
How to buy more stocks
If you intend to buy more stocks, options could be a better options to buy more stocks. If you would like to know more about options trading. We at HustleVentureSG have covered an in-depth analyses on Options Trading. Essentially, an investor is able to buy a 100 shares of a company and get paid a premium for the purchase.