Everyone is talking about it. Everyone is anticipating it. Everyone is scrambling for contingency plans to overcome it. What is “it”? “It” is the strong probability of a global recession.
So, what is a recession? It refers to a decline in general economic activity typically recognised after two consecutive quarters of negative gross domestic product (GDP) growth rate. There are many ways in which a recession is caused; for example, the 2008 Global Finance Crisis (GFC) was caused by several factors such as the high default rate of the subprime home mortgage sector and the collapse of large financial institutions. A recession is usually the result of a combination of factors such as demand or supply shocks, interest rate hikes, sharp increases in commodity prices, etc. A recession has catastrophic effects on both the economy and the standard of living of people since many lose their jobs, consumers spend less, and businesses go bankrupt. Approximately 8.8 million jobs were lost in the aftermath of the last global recession following the GFC.
“Our Economy is sooo strong, sorry!”, tweeted U.S. President Donald Trump in late August, assertively responding to the forecasted recession whilst the global economy faces uncertainty on several frontiers. Trump and his administration are arguably justified in their confidence that the U.S economy will brave this storm. The reasons for this optimism are the 50-year record low unemployment rate and steadily growing wages, which means consumer spending is expected to remain strong. On the flipside, the more despondent economists are alarmed by the recent inversion of the yield curve. The yield curve maps out the treasury bond returns across different maturity periods. Normally, longer term bonds promise higher yields compared to shorter-term bonds. But when future economic outlook turns bleak, investors tend to park their funds in safe assets like long-term Treasury bonds. When the demand for longer-term bonds increase, their yields drop in comparison to shorter-term bonds. A sustained demand for longer-term bonds gets the yield curve to a point where the absolute yields of longer-term bonds fall below those of shorter-term bonds. Thus, the curve inverts as shown below with the US 10-year bond yields falling below the 2-year bond yields.
Inverted yield curves have accurately heralded all nine previous recessions in American history. Although every yield curve inversion has not been succeeded by a recession, the current inversion is a strong signal to the world that the possibility of a recession is anything but remote. The Trump administration’s optimism appears misplaced when we consider other worrying global market developments such as the China-American trade dispute which has caused a dip in global trade. Trump has failed to realise that along with Chinese companies, even American companies are worse off after the escalation in the tariff war. For instance, US steel, which was meant to be protected from low-cost Asian & European imports, has instead found its turnover and stock value at an all-time low, forcing them to lay off workers. The likelihood of a No-Deal Brexit, which might cause a 3.5% decline in UK’s GDP, is troubling investors, many of whom are convinced that the UK is already in recession. The central bank of Germany also forewarned that the country is facing recession as a result of the global trade uncertainty and the already slouching sales of German carmakers & industrial rigs manufacturers. Even the Asian economies of Singapore and South Korea, together with important emerging economies in South America such as Brazil and Argentina, are experiencing an economic downturn.
The impact of these global developments on Australia, which is currently having its 28th year of economic expansion, is a subject of intense discussion. The ASX 200 Index is near record high, which can easily be a precursor to an imminent recession. The Australian economy, being a net exporter, has a direct correlation to the economic health of its trading partners, especially China. Our merchandise exports to China in the previous fiscal year stood at $133.8 billion and accounted for 36% of our total merchandise exports—much more than Korea, Taiwan, the US, Japan, and the EU combined. Similarly, students hailing from China make up over 33% of all international students enrolled in Australian universities, which is more than twice the number of students from the next most common country, India. Thus, Australia is poised to be caught in the crossfire if the Sino-US trade war escalates further.
When the markets do crash, equities will likely take the hardest hit. Asset managers are increasingly advocating towards diversifying investment into balanced and recession-proof assets in order to reduce downside risk. Safe-haven assets, such as gold and the Japanese Yen have experienced rallies over the past several months. Being able to branch out from equities into unconventional assets will prove to be useful. It is important to not panic if the economy enters recession. Long-term investors must continue to play the long game and must refrain from liquidating their portfolio if it loses value. No recession has ever been permanent; moreover, after each recession, most developed economies have made a more-than-full recovery.
We conclude with a discussion on the impact of recession on our readers—primarily university students. A recession can mean a reduction in casual or part-time jobs in cities and elsewhere, causing a fall in disposable income. Students are therefore encouraged to be smart with their spending habits and save up for a rainy day. For graduate students or students in the final year of their degree, a recession brings uncertainty regarding future employment. During a recession, businesses tend to struggle due to lower consumer spending or higher fixed costs in proportion to revenue. Thus, recessions coincide with a cool down in recruitment.
Students will have to be more proactive when seeking employment. They could reach out to potential employers ahead of graduation through platforms such as company websites or LinkedIn. Although big multinational companies with their fat salaries are a big draw, students should be willing to start at small or medium sized enterprises that can offer several opportunities and have a high potential for learning. Students could also get involved in not-for-profit organizations where they will develop several skills considered valuable by employers. It is just a matter of weathering the storm in case it takes longer than expected to find employment. The intermediate period can be fruitfully dedicated to building your skillset so that when the economy takes a turn for the better, you are ready and confident to take on the world.
The CAINZ Digest is published by CAINZ, a student society affiliated with the Faculty of Business at the University of Melbourne. Opinions published are not necessarily those of the publishers, printers or editors. CAINZ and the University of Melbourne do not accept any responsibility for the accuracy of information contained in the publication.
Laukik is a Master of Finance student and a CFA Level 3 candidate. An interest in global economic developments, technological advancements and investment strategies has driven him to pursue a career in asset management. When his head isn’t hidden behind a laptop, he is in the gym doing burpees and mountain climbers!