TSI #16: What to expect from this recession

Hi Stoic Investors,

Today I want to give you the expectations for the worst recession of your life.

Wait, wait, wait!

I don’t mean to say that this recession will be the worst one for sure.

As you know, it’s pointless to predict the near future.

The market could go up, down, sideways or jumping in circles.

But just for today, I want to take the side of the pessimistic investors that are calling for the end of the (financial) world.

Why?

So that you can build a plan that works even if (and that’s a big IF) the upcoming months will be actually as tough as some people believe.

Because once you are planning for any scenario, nothing can stop you.

So today we are going to cover:

1. What to expect as investors from this recession
2. What I will personally do in this recession

So, let’s go!

1. How bad can this recession be, based on data?

The S&P500 Index had its worst first half since 1970.

Inflation, War, COVID19, interest rates going up.

It has been a... Interesting year.

What can we expect next?

Bloomberg Intelligence predicted the following scenarios for the next months:

Let’s analyze the different scenarios.

For reference, at the time of writing the S&P500 is around 3,600.

1. Bull Scenario (S&P500 to 5,000): Inflation dies down quickly and the Federal Reserve (FED) doesn’t need to raise interest rates to counter it.

The market recovers to the previous highs in the next 6 months. 

My personal feeling for the likelihood of this scenario is very low.

There are just too many uncertainties and too many unprofitable companies around that have been created in the past few years with debt.

Until the market is “cleaned up”, the short-term potential for big gains is low.

Personal feeling for this scenario likelihood: 10%.

2. Base case (S&P500 to 4,000): Inflation is stationary for the next 6-12 months and the FED can be less aggressive with interest rates. 

The market starts to get used to a new balance: unprofitable companies disappear and solid companies earnings help the economy to grow in a sustainable way.

Personal feeling for this scenario: 30%.

3. Bear scenario (S&P500 to 3,600): once more, the expectations for inflation and its consequences get underestimated. 

We get a worse-than-expected economic recession and business struggle for few years.

The stock market stays quiet with no particular gains at market level (e.g.: S&P500), while new single companies emerge from victorious from the recession.

Personal feeling for this scenario: 50%

4. Stagflation scenario (S&P500 to 2,500): stagflation happens when ​​there is persistent high inflation combined with high unemployment and stagnant demand in a country's economy.

In this scenario, neither the central bank (FED) or the government have much power to adjust the economy.

However, right now the signals for such a scenario are very weak.

For example, unemployment rate in US is just 3.5%, much lower than the long term average of 5.74%.

For reference, a similar drop in value of the stock market would be similar to 2008 levels.

Personal feeling for this scenario: 10%

So here you have it. 

As you can see, I am not very bullish in the short term.

But as usual… These are predictions. They are never perfect and I would not choose my investment strategy solely on these.

I prefer to look at long term data like these:

In other words: if you have a long timeframe, you will be fine.

Let's now cover how to move in this environment.

2. What I will personally do as Stoic Investor

Let’s start from an important datapoint.

I plan to invest for the next 20 years.

Any discount on the market is a blessing for me and any investor with a similar timeframe.

You are simply buying the same assets at a cheaper price.

At the end of 2021, I started to accumulate cash, as it was very clear that everything in the market was overvalued.

I am now starting to deploy that cash - GRADUALLY - into businesses with strong cashflow, like Microsoft.

Why?

Because companies (or sectors) that do not need to borrow money to survive can simply sustain themselves with internal revenues even during economic recessions.

The Era of easy money, crazy companies with crazy promises is over.

With interest rates going for 4-5% in the next months, companies cannot simply borrow money and wait to be profitable in 5-10 years.

They will die from interest rates before then.

And this is true also for crypto: all the crazy promises of “guaranteed” gains are disappearing. 

Finally, only the really valid businesses are resisting.

Imagine this recession as a way to cleanse the market from ridiculous businesses that were able to thrive only due a unique environment of zero interest rates.

These businesses are going to disappear to leave space to the next Amazon, Microsoft or Apple.

This is the right time to find them.

This is your chance to create generational wealth.

Just remember this:

“You make most of your money in a bear market, you just don’t realize it at the time.”