Introduction: Another recession, possibly a very serious one, is inevitable. We know it will happen, for it is part of the normal business cycle. The problem is that we don’t know when it will happen. It might be this year or it might be years / decades from now. Whenever it occurs, there will be people who suffer from the crash. They did not prepare for the inevitable. They were surprised when it happened. And they don’t know what to do now. There will also be people who will come out the other side in a better overall financial position than when the recession began. Most of those latter folks will have an idea of how long the recession will probably last, how serious it might be, and what it could take to make it go away. Those are important metrics, even if they are soft numbers. A person who gets those items mostly right will have a very different future than the person who gets them mostly wrong.
The thing about recessions is that they expose the conflict between entities with significant discretionary income (allowing them to benefit) and those having too high fixed expenses (ex: debt, overhead, alimonies). But even the entities (corporations, individuals, philanthropies) with high debt levels often have some assets that are free and clear. Given a deep enough recession, these will be available for purchase, possibly at a very favorable price. Art. Illiquid investments. Buildings. A recession can be a good time to be a buyer.
Buffett was right: “You never know who’s been skinny-dipping until the tide goes out.”
Collector > Scarcity
A little story (names and some details changed): Hera-the-cat-lady loved her long-haired Ragdoll cats. They were like children she never had. She was a pushover for their trusting blue eyes and passive demeanor. In addition to her Ragdolls, she had a small collection of silver-plate tea pots. Her habit was to buy an antique teapot every time one of her divorces was finalized. As her nuptial experiences broadened she was able to buy increasingly expensive pieces. When her last divorce was finished, she bought a beautiful Gorham sterling silver tea and coffee service made in 1882. That was when she divorced the most recent ex-husband, the former furniture salesman who bought a small bank in a large city and turned it into a source of hard-money loans for commercial properties. When they split up, Hera had two thoughts, one directly on the heels of the other: (i) “I never knew he had that much money!” followed, without a pause, by (ii) “I deserve more!”
Hera loved to travel. When she was still pre-menopausal, she would visit museums if they were not too far from the hotel she was staying in. On one occasion, the curators of a famous museum back east were displaying amongst themselves their newest acquisition, a sterling silver neoclassical tea pot. Hera drifted over to flutter on the periphery of the group, watching and listening. It was one of only six that Paul Revere, he of Longfellow’s midnight ride, made in the late 1700s. Hera was on her third husband when she saw it. And she knew immediately that she would have it one day.
Now, the latest recession cometh and the museum, like so many others, was experiencing financial difficulties. Their endowment was shrinking. Their capital base was eroding. Benefactors who promised contributions were no longer able to perform. Even entrance and parking fees were less than they’d hoped for. Insurance costs rose. Taxes inched up. Maintenance expenses increased as a percentage of income. Repairs that had been postponed during the good years became critical.
Hera recognized a classic case of high fixed expenses (them) vs. a naïve and helpless woman with significant discretionary income (her), and she knew what to do. She became a sponsor of the museum, letting them know that her greatest interest was antique tableware. She became friendly with a couple of the directors, separately encouraging them to talk freely about the museum’s dismal economic prospects. When she judged the time to be right and she could get her director-buddies alone, she, as if the thought had just come to her, suggested that the museum may wish to encourage public members of the museum to “sponsor” an artifact or two. She would volunteer to sponsor the Revere teapot if no one else wanted to.
The arrangement they finally made was that Hera would auction her Gorham tea and coffee service and donate the proceeds to the museum. The museum, in turn, would gift her the Revere teapot. Hera would leave the teapot in the custody of the museum for 12 years, at the end of which the museum would have the right to purchase the teapot at whatever the then-appraised value it might be. The result of this arrangement was (a) the museum got desperately needed funds and (b) Hera turned her Gorham service into either (1) the Revere teapot or (2) a financial windfall.
It was win-win: if the museum failed to buy the Revere back, the teapot would be hers to take home for the (already paid) donation the Gorham brought twelve years earlier. Hera would win. If the museum bought the teapot back, Hera would receive the difference between its then current value and its past value during the severe recession, twelve years past. Hera would win again.
The point here is that anything by Paul Revere has greater rarity than anything by Gorham, and for a collector, scarcity generates value.
Investor > Labor-Saving
Now, consider an investor in the midst of a serious recession. He might sell stocks in old technology (ex: iron casting factories) and make investments in new (disruptive) technologies. A historical example might be the Sears, Roebuck catalog in the early 1900s which displaced the general stores at thousands of crossroads. Later, Walmart (lower prices) displaced Sears. Then Amazon (even lower prices) replaced Walmart. One day, something will probably displace Amazon.
A contemporary example is the computer revolution which enabled greater productivity, whether at work or at home. For the investor who predicts correctly, disruptive technology has been a remarkable source of wealth.
The Great Depression, as terrible as it was, was not black for everybody. Some people (not many, but some) came out the other side with greater wealth than they had when the Depression started. Many of those investors accumulated assets as did Hera and the disruptive technology guys. During the terrible years rare things of great beauty became available at very favorable prices (the Hera approach).
Another example of the disruptive approach might be the buying and incorporation of contiguous small farms into a single large holding. This made the purchase of large, labor-saving agricultural machinery economical. Things like irrigation systems, cultivators, harvesters, and sorters significantly increased efficiency while lowering labor costs, making their payback period acceptable. Disruptive technology replaces human labor.
Recession > What to Expect
The period between 1929 and 1938 featured two simultaneous debacles, with nearly perfect overlap: (a) the stock / bond implosion centered in New York and (b) the Dust Bowl collapse whose epicenter was in Oklahoma. They had totally different causes, and neither was a primary effect on the other. Those Oklahoma farmers did not have stock portfolios, and the New York fellows did not have farms. The collapses appear to be independent.
An entire economy simply doesn’t get shut down without consequences. There are always repercussions, most are predictable, but others are largely unexpected. The repercussions, both predictable and surprising, can be incorporated into five quantifiable elements: (i) how long the downturn lasted (duration), (ii) how deep it was (decline in the gross domestic product), (iii) employment losses (peak unemployment), and the (iv) beginning and (v) ending yield of the 10-year Treasury note. Items (iv) and (v) are factors in the cost of recovery. The cost of recovery is found by subtracting the rate of the 10-year Note at the end of the recession from its level when the recession started. These elements allow the reader to form an opinion on the most likely dimensions, the length, depth, and width, of recessions, whether prospective or historical.
Duration: Short (1): By definition, a recession is two consecutive quarters of negative economic growth, so the minimum qualifying length for an economic correction to become an official recession is six months (two quarters). Between the Depression of 1929 and the Great Recession of 2007 (inclusive), a period of 78 years and spanning 13 economic corrections, only the Recession of 1980 was as short as six months. That’s one of 13, or about 8% (rounded) of the data points, and suggests that minimal length recessions are relatively low probability events.
Duration: Medium (8): There were three recessions of 8 months apiece (1957, 1990, and 2001). The immediate post-WWII recession (1945) lasted for 9 months. The 1953 and 1960 declines were 10 months. Both the 1949 and the 1970 recessions continued for 11 months. Those eight recessions, over half of the samples, had lengths of 8 to 11 months. It’s a small data base – 13 including the Depression – but the weight of the data is in mid-length recessions running from more than six months but less than a year. These eight mid-length recessions constitute 62% (rounded) of the data points. If the 1980 short-term recession were included, nearly 70% of the 13 recessions lasted less than 12 months.
Duration: Long (3): Then there are the greybeards. The 1973 and 1981 recessions were each 16 months long. The 2007-2009 Great Recession lasted 18 months. Three out of 13 is 23% (rounded) of the samples.
Duration: Longest (1): The outlier is the Depression of 1929-1938 in which the economy was underwater for a decade. This economic collapse was a general catastrophic event aggravated by the Dust Bowl, one of the worst environmental disasters of modern times. The timing of the Dust Bowl (1930-1940) coincided with the Depression (1929-1939), which makes it pretty bad. One out of 13 samples is 8% (rounded).
Continued next month . . .
This article is for informational purposes only and is not intended as professional advice. Nothing in this article is presented as investment guidance. For specific circumstances, please contact an appropriately licensed professional. Klarise Yahya is a Commercial Mortgage Broker specializing in difficult-to-place mortgages for any kind of property. If you are thinking of refinancing or purchasing real estate Klarise Yahya can help. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].