Are We Overdue for Another Recession?

Are we overdue for another recession?

Who knows, and should you care?

Now, I know I’m not qualified to write about, or speculate about when the next recession will hit, or what will be the likely cause of the next recession. I don’t think there are many people who are qualified to speculate- But I’ve done some reading.

Just like at the beginning of 2018, there have been a number of articles and news stories talking about the next recession, and how it’s just around the corner. They may be right, or they may be wrong. Only time will tell.

Back in 2018, there was speculation that we were going to be in a recession because the year ended with an 8, and historically years ending with 8 are meant to be unlucky for the New Zealand economy. There was also the fact that it had been 10 years since our last recession. And ten years is about the average time between recessions.

ANZ Chief Economist Sharon Zollner says that ten years is about par for New Zealand’s economic cycle.

But the recession didn’t eventuate in 2018 at all- but that doesn’t mean that we won’t be going into a recession now.

Historical perspective on Recessions

Being quite young, I haven’t gone through a recession in my entire investing or work career. And that can be scary as I don’t know what to expect. I don’t know what’s supposed to happen in a recession- and every recession seems to be different.

Recessions generally mean that the share market will crash. It will be interesting to see how I will behave in terms of my investments.

Since I haven’t gone through a recession, I thought I’d learn a bit about previous recessions New Zealand has gone through. To try and understand more about what causes them, what happens to the New Zealand economy and Kiwis, and if there is anything to learn from them. And then I’ll share what I learn with you.

What is a Recession?

It’s common to hear the word recession in the media, but what exactly is a recession?

A recession is a period of time in which the economic activity is falling, or going down. Basically, the outlook of the economy is bad, businesses aren’t hiring new people, or making as much profit. Unemployment rises, wages don’t grow, and less money flows through the economy.

Many people cut back on unnecessary spending and travel during a recession, because they might feel like their jobs might be in jeopardy. This, in turn, fuels the recession. That’s my basic understanding of what a recession is.

Historical New Zealand Recessions

There have been a number of recessions in New Zealand’s History. Each recession can reveal important factors and event that are likely causes of the recession. Each recession can also show us the impact of the recession on the economy.

The Great Depression -1930

At the time of the great depression, around 80% of our exports were agricultural-based and sent to Britain. Talk about diversification. Since the great depression was worldwide, Britain was also affected. And since Britan was in recession, they were buying less of the exports from New Zealand- this, in turn, caused the New Zealand economy to go into a recession.

There is much debate around what caused the great depression. Many people believe it was the stock market crash in the US- followed by the US federal reserve to increase interest rates sharply. Post-war Europe was also very dependent on borrowing money from the US. So an increase in US interest rates plunged the world into the great depression- an extended period of recession.

The effect of the great depression in New Zealand was mainly the fall in export prices. Farming export prices fell, at one point falling by 45%. Farmers tried to increase production to maintain their incomes, sell more for less- but they couldn’t maintain their income. That lead to farmers spending less money- followed on by less spending in the rest of the country and an increase in unemployment, which peaked at 20%.

The government at the time had a large debt on the books- around 160% of GDP. Tax revenue collected by the government fell and since it was believed that a government needs to maintain a balanced budget, the government decided to cut core spending and raise taxes.

The Wool Bust -1967

The wool bust of 1967 has similar undertone as the recession in New Zealand caused by the great depression. Our exports were not diversified and still very agriculturally based. In 1966, 31% of our exports were wool.

In the early sixties, wool prices were booming. That leed to income rises in New Zealand. People had more money to spend, so our imports increased.

Then the wool market collapsed in 1966. New Zealand lost 12.5% of its export income overnight. International wool prices dropped 20% in 1966, then a further 20% in 1967. The NZ wool commission decided to buy the surplus wool to keep the NZ farmers going- but this only kicked the can further down the road.

There was no worldwide recession at the time, which makes this recession unusual.

The First Oil Price Shock – 1974

OPEC (Organization of the Petroleum Exporting Countries) is a collaboration of 14 oil-exporting countries. They generally control half of the worlds oil production and nearly 90% of the worlds proven reserves.

OPEC in 1973 decided to flex its muscles and increase the price in oil through limiting the supply. The price of oil double between December 1973 and January 1974.

The increase in the price of oil slowed the economy down. Unemployment rose, the share market fell, and inflation increased- similar effects to other recessions.

The Second Oil Price Shock- 1979

Just as the New Zealand economy started to recover, the second oil price shock recession started to kick off in 1979. The price of oil increased following the Iraq war. The price of oil increased by 150% over the following year.

The recovery of the economy stalled, carless days were introduced to try and reduce oil consumption. Unemployment increased and people left the country by the thousands.

The government wanted to boost the economy and developed the think big strategy. Where the government would spend large on big infrastructure projects like the Clyde dame, the Tiwa aluminium smelter, and the expansion of the Marden Point oil refinery.

The 91 Recession -1991

Just a few years earlier the infamous 1987 share market crash had occurred. Share prices more than doubled between July 1984 and the end of 1986.

On 19 October 1987, what’s now called Black Monday, share prices collapsed around the world. In three-and-a-half months, the value of the New Zealand share market halved.

The 91 recession was a bit different from the previous two recessions. Oil prices started to fall. Inflations and consequently interest rates started to decrease. Welfare support from the government was decreased. And house prices fell.

The Asian Crisis and Drought – 1997

The Asian financial crisis in 1997, saw a number of important Asian economies forced to float their exchange rates- letting the market determine the value of their currency. This left many Asian currencies to fall very sharply, leading to serious losses in the banking sectors.

Alongside the financial losses, New Zealand was in a two year drought with the east coast of New Zealand recording the driest year on record. The drought had a huge impact on agriculture, which then spread throughout the rest of the economy.

The 2001 Global Slowdown

Surprisingly, the dotcom crash did not result in a recession for New Zealand. This tells us that it’s normally a combination of factors both international and in New Zealand that results in a recession.

The GFC 2008

The GFC was another beast altogether, fueled by sub-prime mortgages and a housing bubble in the US. When the bubble burst many financial institutions went bankrupt and many homeowners were forced to foreclose on their mortgages, often losing their home while still being in debt.

Fortunately, the recession for New Zealand was relatively small compared to what many other countries went through at the time. The economy emerged from recession in mid-2009.

Factors that Cause Recessions

While reading about these historic recessions I noticed that there seem to be some trends about what can cause them. There seems to be a pattern where an imbalance emerges in the markets, and then a trigger that causes the start of the recession.

Some of the imbalances that seem to be present in several of the historical recession include;

  • Rapid Increase in Asset prices such as real estate and commodities like oil
  • High-interest rates affecting the amount that can be lent, and the cost of the lending
  • High levels of inflation
  • A large amount of Government and or public debt
  • The Government, or New Zealand, running a deficit

Some of the triggers that have caused the previous recessions to include;

  • A turndown in the world economy
  • A large drop in commodity prices- such as wool
  • A large increase in commodity prices- such as oil
  • Interest rate rises
  • Limited global credit being available
  • Tightening of New Zealand monetary policy

It’s interesting that some of the market imbalances that cause the recession are also the triggers of the recession, while other market imbalances do not cause the recession but rather collapse after the trigger has caused the recession

Should You Worry?

It’s been interesting looking back at previous recessions. But should you worry about the possibility of an upcoming recession?

My short answer is no.

For a few reasons, I think you shouldn’t worry.

The first reason is that no one knows when a recession is going to hit. People have been talking about the next recession for years now. Yes- you need to be somewhat prepared for a recession- but you shouldn’t worry about something that may or may not occur in the near future.

It might be a different sorry if you are heavily mortgaging. The possibility of a recession causing house prices to fall may put you into a position where your mortgage is larger than the value of your house. If you are in this situation a recession won’t be good for you.

The second reason is that you should be investing in shares over a long time horizon. This will allow you to rid out any recession. Even if you share price falls during a recession- you should just hold and wait for the recovery. If you sell during a recession you are locking in your losses.

Take a look at the graph below of the NZSE40 and NZX50 from 1949 to today. It has all the recessions marked on it- use the slider to zoom in. You can see that after every recession the market has nearly recovered 2 to five years later, with the exception of the 1987 stock market crash- which took much longer to recover.

New Zealand Stock Market and Recessions

 

Let’s say that you where the worlds worst investor and invested lump sums of money into the stock market right before every single recession. And you started investing in 1972, just before the first oil crises. Your investment and subsequent losses form the crash in the stock market are tabled below.

Date of InvestmentAmount InvestedSubsequent CrashInitial Losses 
December 1972$5,000-14%-$739
November 1975$10,000-7%-$703
December 1986$48,000-38%-$18,360
August 1988$15,000-19%-$2,863
November 1998$82,500-15%-$12,688
September 2007$100,000-33%-$33,102
Total$260,500-$68,456

How much money do you think you would have today? Even though you bought at the top of the stock market every single time. Your investment would now be worth $1,012,474.

If you were the worst investor ever!

 

So you would still come off ahead if you were the worst investor in the world. You took a 38% hit when you invested just before the 1987 stock market crash. Then you took a 15 per cent loss after the Asian Crises. You would still have quadrupled your money!

Now, rather than being the worst investor in the world- if you had used the dollar-cost averaging method to invest the $260500 over 46 years how much would you have then?

Dollar-Cost Averaging

 

If you dollar cost average, rather than invest right before a recession you would end up with $2,045,555 after 46 years. And throughout that entire period, you didn’t worry about recessions at all.

You went through some of the biggest recessions new Zealand has seen and still managed to grow your initial investment by 8 times. Even though there where years where the stock market dropped by 10’s of per cent.

  • The First Oil Crisis -17%
  • The 1987 Stock Market Crash -38%
  • The Asian Crises -15%
  • The GFC -33%

Your money still grew because you were in for the long run and the average return of the New Zealand market over the last 69 year has been 7.8%.

So, are you worried about the next recession?


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5 thoughts on “Are We Overdue for Another Recession?”

  1. Thanks for posting that , it is a well researched and balanced article and I enjoyed reading it.
    I enjoy visiting your site and receiving your posts
    Cheers
    Julian

    Reply
  2. That person is not the worst investor since s/he did not panic sell. 🙂 And that’s the whole point isn’t it. Keep calm and invest on.

    Reply

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