What is a “recession,” and why does it seem like more and more people are talking about it? In this episode of Coffee with Brendan, Brendan dives into this complex topic, explaining how inflation can lead to a recession and what you can expect if we do experience one.
Current causes of inflation
How curbing inflation can lead to a recession
The ripple effects of a recession
Bouncing back from recession
Hi, and welcome to a rainy Monday edition of coffee with Brandon. Today we're going to talk about recessions. That has been a common topic that some of my clients have been asking me about. But also, just we hear it in the news. And what today's video will be is to discuss why are we talking about this seems like it's been definitely a bigger topic of conversation just in the last few weeks, and how does it impact you. So let's just jump right on in and try to explain why this conversation is starting to pop up. It all comes down to inflation. I know that is a word that not too many people want to hear about these days, because seems like everywhere you turn, the price of everything is that much more expensive. So inflation is not a fun topic to talk about. But that is pretty much where we have to start when we talk about recessions.
So why are why do we have this inflation issue right now? And the answer is that there's a gigantic imbalance between the demand for goods which is way high, and the supply of goods, which is very low right now. And why are why is the demand for good? Or why is the supply of goods? Very low right now? The answer is, a lot of you know, a lot of this kind of dovetails in with COVID. You know, right now, China, which supplies many of our goods, has been operating at a fraction of its typical production. And so things like refrigerators, things like and, you know, name, anything, a lot of stuff comes from China. And the supply of that is very low right now, however, the demand for all that those goods are very high.
Similarly, you know, we look at gas, and I'm going to try desperately during this video not to walk into any minefields here of a political discussion. But one of the big reasons why gas prices are so high right now, is that Russia, invaded Ukraine. And when Russia invades Ukraine and the world for all intents and purposes boycotts, 10% of the world's oil supply, that means the other 90% of oil that's out there is in much higher demand. And so the oil producers know that the people that make refrigerators know that the people that make cars know that, that if you have a high demand for stuff, and a low supply of stuff, there may be five buyers for every one unit of whatever you're selling.
And so therefore, you know, if the first person or even the first couple people don't buy, you're good, you'd go to the second, third and fourth person to buy or good at whatever price you're willing to charge them. And that's one of the main issues that's going on right now is that there's this gigantic disconnect between supply of goods and excuse me, demand for goods and supply of goods. So how does that relate to the concept of recession?
Well, there's only two real ways to combat inflation. One is we have to bring this back together, you know, more closely together. So you can increase the supply of goods, which again, we don't have that much control over, we can't tell Putin to to get out of Ukraine so we can buy as oil again, or have the rest of the world buys oil, we don't buy that much oil from Russia. Again, another thing and again, try not to wander into political things. But you know, when the supply of oil in the United States could be increased, you know, based on some of the the programs and some of the things that the current administration has done. I'm gonna leave it at that. The impact of that is very debatable.
The other piece of this is the supply from China. So again, once China is done with COVID, hopefully the factories will reopen, people come back to work and that supply of goods will come back, you know, think back to the old PPE, you know, the protective equipment like masks and gloves and all that kind of stuff. You know, we were at a very low supply of that stuff. And so it was very expensive to get those that protective equipment. But eventually China came back online and supplied us with all the protective gear that we want it same thing with refrigerators, cars, etc, etc. So one way of addressing this is supply but is to is to attack the supply. The only challenge with that right now is that our ability to impact supply is somewhat limited because it is governed by other outside of the United States countries.
So what has the Fed tried to do? They've tried to since supplies not going anywhere, anytime soon, they've tried to bring down demand. Now, how do you bring down demand you raise interest rates. So a couple of weeks ago, they raised interest rates by point seven 5%. What does that ultimately do? What that does is it reduces the number of houses that are purchased. And there's a ripple effect from that, if they're if people are not buying houses as much, because mortgage rates are so much higher, then they don't go to Home Depot, they don't hire contractors, they don't. So there's this ripple effect that when people stopped buying houses, or curtail their buying of houses, other industries and other places of employment are impacted. Car Loans, same thing. Credit cards, same thing, what they're trying to do is ultimately try to drive down demand and make it more onerous to buy stuff.
Now, eventually, that will probably impact things. And and frankly, a lot of times the fed into history has, as they call it tightening, they've, they've increased interest rates so much that becomes so onerous that people don't buy stuff anymore. There is a double edged sword to that, however, and this is where the recession, conversation starts coming in. If we look at, at what, what makes up our economy, what makes up our economy is right here, 68% of the economy is driven by consumption. So when you have this overactive fed, that's reducing consumption, reducing demand, what ultimately happens to the economy, the economy starts contracting. And when the economy starts contracting, that's when the concept of recession comes in.
And so, you know, what everyone wants to know is, what is a recession? You know, what is the definition of a recession? The definition of recession is right here, it's pretty much it's pretty much a significant decline in economic activity, it lasts for months, or even years. And what happens during a recession? Well, if if there's a smaller demand for goods, then then guess what, you know, when there's a smaller demand for goods?
I always like to use the idea of Apple or the the example of Apple. So let's say people are not buying as many iPhones anymore. What does that mean to Apple? Well, profitability probably comes down. And what is what does Apple typically do when the profitability of Apple comes down? Well, number one, their share price goes down. So the stock market typically gets hurt. But then also, they may start laying people off, you know, they may start laying people off at Apple stores, they may start closing Apple stores.
So there's this again, snowball effect that happens when consumption starts declining, and people stopped buying your goods. And so again, all these things kind of play into a recession. So ultimately, this is a this is a good list of things that could happen, you could lose your job, that's probably the biggest thing. And the biggest concern that most people have, when it comes to a recession is that they could lose their job because a lot of people's financial futures are based on their ability to bring in income on a recurring basis. They can't save money into their 401k they can't invest if they can't buy houses, all those things are, are consequences to someone losing their job, but then you know, as but as we talked about, you know, the stock market tends to go down. Business owners tend to go out of business. So some of the weaker businesses go out of business. You know, if you can't pay your bills, then you know lenders like banks, they stopped lending.
So long story short, lots of different bad things can happen during the recession. But a key a key thing to take to remember is that recessions are natural. This is the business cycle. There are expansions and then there are contractions and recessions.
Now what we don't want as a depression, but that's typically when you know the the there's something much more sick with the economy. If There's a depression that typically lasts for years as opposed to several months. So, everyone always asked me the same question.
Okay, let's say that we're in a recession, what does that mean to my portfolio? So let's take a look at that. So historically speaking, when it comes to a recession, this is what you should expect is that the historically, the meat I like to use median, so the median of rates of return of a portfolio or negative 24%, during the worst of this market, which happened right around the time, the Fed dropped its interest rates in June of 2022, the market was down right around this 24% number. But then look what happens a year later. And two years later, again, median, and this is historic. So no, no promises here.
But historically speaking, the market bounces back pretty dramatically one and two years out. And why is that? Why? Why does the market bounce back pretty, pretty? Consistently? Well, if you think about it, it actually kind of makes sense. Like, let's go back to our example with Apple. So Apple starts shutting down stores, starts laying off people, etc, etc. Well, guess what they're making some changes to their business, that are probably good changes that they should have made while they were expanding. But you know, at the end of the day, they they, they weren't making these hard decisions, like shutting down stores that are not as profitable as other stores, laying off people that aren't as productive as other other people. So there's a pruning that happens. And just like when you're in your garden, and you prune back some some I hate to refer to people as dead wood. But when you think about it, you know, that's what you do. When you're pruning, you get rid of some of the parts of the plant that aren't performing as well. So that you can let other ones do a lot better.
And this is the thing, this is recessions are natural. And, you know, while you're in the middle of the recession is not so good. But on the other side of it, historically speaking, of course, you're looking at greener pastures ahead. So again, no promises here, I can't I can't predict what's actually going to happen. We may not even go into recession. Now. That's what's called a soft landing, you know that the Fed is able to reduce demand, but not trigger recession. That's what everyone's hoping for, but the I'll tell you, you know, more and more economists are actually casting some doubt on their ability to to coordinate that type of soft landing.
So there you go. There's recession in a nutshell there. Hopefully, I've answered some of the questions that you may have recessions bad while you're going through it, not so bad coming out of it. And typically, the market has, historically speaking, recovered from it.
So hope you have a nice week and I hope this was helpful, and I look forward to our next conversation. Bye bye.
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