#6 | Demand Destruction and the Coming Recession

Jon “Jag” Gay: Welcome into episode number six of Protecting and Preserving Wealth. I am Jon Jag Gay joined as always by Bruce Hosler of Hosler Wealth Management. Bruce good to be with you as always.

Bruce Hosler: Jon, thank you. And welcome this morning.

Jon: So today we’re talking about a really interesting topic and the name really catches my attention too. That is demand destruction and the potential coming recession. So, what exactly is demand destruction?

Bruce: Jon demand destruction is what the federal reserve is trying to create right now when they raise the interest rates like they are.

Jon: Mm-hmm.

Bruce: By raising the interest rates, they are trying to slow down the US consumer from buying and consuming, due to the higher interest rates. So this will slow down the economy. Usually it will throw us into a recession and thereby slow down the high inflation rates that we’re currently experiencing.

Jon: So, are you saying the federal reserve could be trying to create a recession Bruce?

Bruce: You know, the federal reserve is definitely trying to create demand destruction, and they’re trying to slow down the hot economy. They would like to avoid a recession if they can, but raising the interest rates like they are and trying to slow down the rate of inflation. It makes it almost impossible for them to avoid a recession. And they know that. J Powell admitted as much yesterday.

Jon: Mm-hmm.

Bruce: They need and want inflation to subside and to do that, they need the economy to cool off and slow down. And in fact, the very definition of a recession is negative GDP or negative gross domestic product for two quarters in a row. We’ve already had one quarter. So they are well on their way on creating that, even though that’s not the desired result that they are seeking.

Jon: So this is always interesting to me about the word recession, because you can’t say we’re in a recession right now. You’ve gotta look back at the data to be able to declare it. So as you just said, first quarter, we had the negative GDP. It takes two quarters. So it’s possible as we wrap up Q2 as recording this, that we could be in a recession?

Bruce: It is true. It may well be that we are in a recession right now. We’re gonna get the second quarter reports probably later in July. And the first quarter of the year, we had negative GDP by about one and a half percent. So there’s a chance that we are, but there’s still a lot of demand in our economy. You know, we’ve been pent up for two years with this pandemic.

Jon: Mm-hmm.

Bruce: Maybe going on three now. It feels like. And just like, uh, you want to go on vacation and enjoy yourself. I just came back from a vacation. We are all champion at the bit to go out and live our lives and we’re willing to spend money and go into debt. There was a report the other day, that credit card debt is going up. The American consumer. Is wanting to spend money. And the fed is trying to slow down that demand.

Jon: That is really interesting. Like you said, my wife and I are going on a big trip at the end of July because you know, we spend about two years, both working from home and being in the house together all the time.

We, we still like each other, but we do wanna get out and go explore things other than these four walls, for sure.

Bruce: Absolutely.

Jon: If we are in a recession, Bruce, what does that mean? Bottom line for stock and bond markets?

Bruce: A recession means that the growth of the economy is slowing. That means less potential growth for the businesses. And generally we will begin to see things like layoffs and we’ve seen some of those already. So with the shortages in workers that we have right now,

Jon: Mm-hmm.

Bruce: Businesses have to slow down a lot more than they are. They have to be concerned that they may not have enough workers. And then they become concerned about not having enough business to support the workers they have. And when they become worried, they begin laying people off. If they’re not keeping ’em busy or keeping ’em fully employed.

Jon: I see.

Bruce: Certainly right now, there are help wanted signs everywhere. And employers can’t find people. They can’t find qualified people.

Jon: Right.

Bruce: But the recession, as it develops, this is situation can change dramatically. And if companies begin pulling back, we’ve seen like Tesla and other companies announcing layoffs of some of their management staff.

Jon: Mm-hmm.

Bruce: This will begin producing less. Companies will start selling less. They will grow more slowly. And it only stands the reason that we’ll likely see the stock market slow in their growth. And sometimes even fall backwards. And that’s why a recession has such a stigma associated with it.

Jon: I’m glad you said that last part, Bruce, because I feel like recession is like the dreaded R word and almost like a four letter word when it comes to talking about the economy and does have a stigma with it, but it’s not the total gloom and doom that everybody pretends it to be sometimes, right?

Bruce: Absolutely. It depends about how deep it is, how long it is, but it kind of resets the price perhaps in the stock market. Resets the bottom of employment. It resets the opportunities for companies to grow from that point. So sometimes it can be cleansing to the economy that’s overheated and needs to have a reset.

Jon: Okay, so we talked about stocks a moment ago. What about the bond markets in a recession?

Bruce: So with the federal reserve raising interest rates, it makes it more expensive for companies to borrow money.

Jon: Sure.

Bruce: So most companies, when they borrow money, they’re gonna borrow money on let’s call it a line of credit. And the things about a line of credit that a lot of people do not understand is that those are variable interest rates.

Jon: Mm-hmm.

Bruce: And so when a business company has variable interest rates on their line of credit, when they’re borrowing money to grow, if the fed is raising interest rates, it makes it more expensive for the company to do business.

So when that capital is harder to come by, They will not borrow as much. They won’t invest as much in capital improvements. They won’t invest as much in their intellectual development and they won’t grow as rapidly because the funds are no longer cheap and easy to come by. So there is another reason that domestic growth will slow in America.

Jon: Ah.

Bruce: Also, if companies have not managed their finances well, we could see some companies struggling to pay their debt obligation. That weighs on the value of their stock.

Jon: Okay.

Bruce: Also, if some of them are mismanaged so badly that they go out of business because of this, we could see some bond holders left holding the bag and lose a lot of money on the bonds that those corporate companies owe.

Jon: That is kind of a vicious cycle. So, I know there’s really no way to predict this. You’re not Kreskin. You don’t have the crystal ball sitting there Bruce, but how long would or could a recession last?

Bruce: Jon, we just don’t know how long will it take for the federal reserve to reverse course and begin raising their rates and then lowering their rates.

So reversing course is when they turn around and say, Hey, we’re done raising the interest rates. Now we’re gonna have to lower ’em because the economy’s gone into a recession and we have to resuscitate it. We don’t know how long it’s gonna take them to react. And that’s the reason that I think. And stated in the title, “the coming recession,” because we believe they’re not gonna be able to Dodge a recession.

Jon: Mm-hmm.

Bruce: So they are playing this impossible game that they’re trying to play it exactly right on how long and how far they raise the interest rates. And certainly they’re behind the eight ball right now on getting this inflation under control, but how fast and how long they’ll raise the rates. We don’t know they’re reacting and they’re adjusting.

And historically, they’ve never been able to avoid a recession. So when they try to stamp out inflation by raising interest rates, it’s like swatting, a fly with a sledgehammer it has devastating effect on the whole economy. But look at the things that we have inflation on – food, and energy and neither one of those are really directly affected by the rising of the interest rates. They have to pour cold water on the whole economy to be able to slow it down.

Jon: Really a tough position to be in. I would not wanna be Jay Powell. He’s in a really tough spot for sure.

Bruce: Yes, for certain.

Jon: So, we talked about effects and what the recession could look like kind of from a macro perspective, Bruce, let’s get down to the brass tax for our listeners. We’re recording this on June 23rd. So what should people do at this point?

Bruce: Jon now is the time for people to work on their portfolio allocation and they need to use investment tools that can give them protection on the downside while still allowing them to participate in the recovery. When it does come. Now at Hosler Wealth Management, we’re expecting a potential Santa Claus rally in the end of the year.

Jon: I like the sound of that. Can you explain what a Santa Claus rally is? Cause it sounds really good.

Bruce: A santa Claus rally is just like Christmas baby. We love to open presents at Christmas and a Santa Claus rally will usually take place at the end of the year. And you know, those stock traders on New York are really good at making sure they hit their year end bonuses. And so a lot of times the market will trade up in November and December. And this year with it being election year, much of the polls and that are casting that we could see a change in Washington. And one of the good things that’s good for the economy, is when there’s an impasse in Washington. So if Biden continues to hold the white house, maybe the Republicans take over one of the houses, either the Senate or the house, then what can happen is not a lot.

Nothing will get through, nothing will get passed. And the markets like that, because that gives us a little bit of confidence that there’s not gonna be big changes. The other thing is it could change some of the direction we have in some of these inflationary decisions. And so there’s some hope that there would be a Santa Claus rally at the end of the year.

You want to be ready to protect your accounts between now and then. So you have to have something that has a buffer or a protection or a floor on it.

Jon: Mm-hmm.

Bruce: And that can also allow you to participate in the market going up. Now many economists are calling for a recession to appear in 2023 or 2024. So as Jay Powell and the fed continues to raise interest rates, it may become more and more difficult. And as that difficulty develops for the companies, it slows the economy. It slows the consumer. The interest rates are higher. I don’t know if energy continues to rise, but it’s certainly, uh, very expensive right now. So you want to be able to provide protection for your accounts until we get through the federal reserve interestrates rising environment.

And that’ll probably be at least through the end of the year and likely into 2023.

Jon: That is really good advice. Before we wrap up Bruce, I wanna come back to an interesting point that you made a moment ago and that has to do with the US government. And again, not a political podcast. We’re not going left, right, blue, red, anything like that here, but from what I understand, with the stock market, not liking uncertainty – if you have one party in control of the white house and both houses of Congress, it’s a lot easier to go further to the left or further to the right, because they’re not acting as a check on each other, but if you have Congress split or one party in the white house and the other party controlling both houses of Congress.

Because, as you said, there’s a bit of an impasse that keeps things almost within a certain range in terms of the economy, you can’t go too far one way or the other. And that provides some comfort I think, for the market, is that the way it typically works out

Bruce: And more importantly than comfort, it’s some certainty. So it’s uncertainty that creates the scare, the fear. We’re uncertain of what they may pass. So when they control both houses and the white house, there’s no telling what they may do. And that creates uncertainty. We get more of a certainty when there’s kind of an impasse and they can’t pass anything because nobody is agreeing on anything together.

And so the status quo was what we get. When we know that we kind of have the status quo, now business people, investors, consumers can all make decisions because there’s nothing going to happen other than the status quo.

Jon: That is a really important point. The other crux of what we’re talking about today, you just said it a moment ago, providing protection on your accounts, but still allowing yourself the upside when things do eventually bounce back. Such good advice. That’s where the key to everything this episode, Bruce, if our listeners wanna come talk to you and your team at Hosler Wealth Management about the current economic situation and more importantly, what they individually can do about it, what are the best ways to find you?

Bruce: So they can give us a call in Prescott here, (928) 778-7666 and Scottsdale, (480) 994-7342. Certainly on the web, you can look us up at, Hosler, H O S L E R wm.com. https://hoslerwm.com/. You can schedule appointment right on the website, right there. And we can meet via zoom. We can meet over the phone. We can meet in person at one of our offices in our conference rooms.

We offer an introductory meeting at no charge. So, uh, we look forward to hearing of any of you that want to provide upside potential and downside protection to your accounts, we have those investment vehicles available. And, uh, look forward to speaking to you about those.

Jon: Bruce, I learn something every time you and I sit down and have a conversation. I appreciate, and we’ll talk again soon.

Bruce: Thank you, Jon.

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