Economic Collapse of 2023: Are You Prepared?

Inflation's at its highest level in decades. Interest rates are rising at an unparalleled pace. S&P is down 20 percent. Is a recession next? We address this and plenty more. Stay tuned.

Welcome to We're Talking Money. I'm Roger Fuller, senior portfolio manager, along again this week with Phil Clark, wealth advisor and owner and founder of OmniStar Financial Group. Phil, 2022, quite a year. 2023, some say we are heading, we're heading down to catastrophe.

As we enter our third pandemic holiday season, some health experts are fearing a surge in COVID cases. Breaking news at 11: a Russian invasion of Ukraine is underway as troops move in. America's 40-year high inflation has already peaked. The big question now: when will prices start dropping? We don't know if it's a recession. What we can say is that if it is one, it's not like anything we've ever seen before.

Is a recession next? Is it imminent? Fill in our viewers on where you think we are now, and more importantly, where are we headed for 2023.

That's a lot of stuff to digest, and I think for our listeners it's not into the world. 2022 was a tough year. It's still a tough year. Some would have you believe we were going to finish, the S&P would finish up 20 this year. Not going to happen. We knew that a long time ago. The numbers just didn't support that.

Is a reset, a recession imminent? Roger, you know my feeling on that. I think we've been in a recession for much of 2022. If you go back to the classic definition of a recession, it's two consecutive quarters of contracting GDP.

Correct.

We had that.

Yes, we did.

So from my perspective, we went into a recession at the earlier part of 2022, in that, say, first, second quarter.

In four decades we haven't seen inflation where it is right now.

Correct. That's huge.

So absolutely.

And it's still high. So you ask, is it imminent? In my opinion, we've been in one. I think in some ways, in some pockets of the economy, we are still in a recession. And I think in 2023, we're going to talk about this in a minute, but I absolutely think we're going to see more of recession-type climate or a recessionary economy.

So in 2023, then, first quarter, second quarter, lack of better terms, we will admit...

Well, we already know that we're in a recession. Now, if we want to talk about models, if we want to look from an economist perspective, then I could say, Roger, a recession is imminent and probably happens. We're forecasting something to the tune of about the 9th or 10th month into 2023 is when it would really become effective.

Let's think about that for a minute. In terms of the GDP, we're probably looking at a 1.9 percent for 2022 GDP. Now, we had that nice third quarter that it went up, and the White House, the current administration, turned that into something of a boon, and all of a sudden people said, oh good, we're coming out of this thing. Well, one quarter doesn't create a trend. And so I think a lot of people were duped, if you will, into believing that, oh well, good, everything's fine. And you saw a lot of money start to pour back into the stock market, only to see that start to unwind again in recent weeks.

And now what you see is this: there's a culmination going on. Corporate earnings estimates still coming down, right? That's concerning by itself. Then you see global unrest. You still have this conflict in Ukraine and with Russia. And while some people say, oh gosh, Ukraine's making headway, well, their infrastructure is being annihilated. So you can say they're making progress, but by whose measure or they may making progress?

In my opinion, there's billions and billions and billions of dollars that have been poured into Ukraine from the U.S. and others, and I think we're concerning ourselves with some things that might become deleterious, in that we're on the brink potentially of a nuclear war here, right? So those things just add to what you're talking about in terms of the imminency of a recession.

How bad will it get? I don't know. But I can sure tell you that we're measuring in aggregate roughly an 80 percent chance that we hit it. And six months ago, the models that we use, Roger, suggested a zero percent chance that we would go into recession. So those models have changed drastically in six months.

And what was the driving force of the change in those models? Was it the inverse yield curve? I should say, historically, when there's been an inverse yield curve, recession follows every time. And so explain a little bit to our viewers what the base is. What is an inverse yield curve? And two, how long have we been in one? And how does this will compare to historical inverse yield curve?

It's a great question. So a yield curve, for people that don't know what a yield curve is, we look at the short end of the curve, so the two-year bonds or two-year paper, and we look at a longer end of the curve, 10-year, and we'll go all the way out to 30.

But typically, for purposes of this discussion, we'll stick to things like an 18-month and, say, a 10-year, and a two-year and a 10-year. We'll look at that range. Back in 2022, second quarter, that inversion started to happen, so we saw the yield curve flip, if you will. Typically you want to see a yield curve low on the short end and high on the long end, so the longer the investment, the higher the interest rate should be.

That's right. So a 30-year bond should pay a much higher rate than a two-year bond, or a 10-year bond should pay a much higher rate than a two-year Treasury. What we have right now is just the opposite. That's the inversion that you're talking about. And so right now we have a two-year is paying more than a 10-year. That's a problem.

So in that case, then, obviously most people, why would you buy a 10-year when a two-year pays more? And so what causes that, and then how do we get out of that?

There's probably a narrow path to no recession next year. I think that path is so narrow that it's unlikely. In fact, we say there's probably a 15 to 20 percent chance that we could find that narrow path.

How do you get out of it? So first, Roger, what causes that inverted yield curve?

Well, one thing is inflation, and we know we have a lot of inflation. That level of inflation hasn't been seen for 40 years. What caused it? Now, a lot of people argue that what caused it is a war in Ukraine. Well, I'm sorry to report that's only a small part of this inflationary environment. We get a lot of wheat and some other things out of the Ukraine and Russia, but that isn't what created the inflation.

If we just back up a few years and look at what the Federal Reserve has printed, we've printed five trillion dollars. And when you put that much money into the system, you're going to inflate things, because all of a sudden money's sloshing around, it's easy to get, banks are lending, people are borrowing, credit cards are abundant. You've got all these forces that are driving prices higher, and demand is huge, supply is not, and so all of a sudden, inflation. And we're still a long way from where the Fed wants it. In other words, their target, we're a long way from getting there.

How does that affect the yield curve? So all that inflation, the Fed has to slow spending, and they start raising interest rates. That's not the only effect, but if you think about it, when they have to start raising those rates, you're affecting the short end of the curve, and up, up, up, up, and eventually we see a higher yield here, and on the long end of the curve a lower yield, and you've got your inversion. That's where we're living right now, and have been since, like I said, about second quarter of this year.

And so that inversion also affects the stock market, because a lot of people will say, if I can put money into a one or two year item, whether it be a CD or Treasury, and get a three and a half, four and a half, even a five percent yield with no risk, why do I want to put risk of being in the market? And so with that being said, what should investors be looking at for 2023? What should they be doing? But more importantly, what are some of the biggest mistakes investors make going into a recession area?

First, let's recognize that when interest rates rise, cost of money is going up. So the cost to borrow goes up, and that drives down asset prices. I'll give you an example, Roger. In January of 2022, you could borrow money on a 30-year mortgage at three percent, and in some areas lower. I saw some bankers doing it at 2.75. That same 30-year mortgage just a month ago was costing you seven percent. And so if you think about that, the person that was buying that half million dollar home in January, they can still buy that half million dollar home in November, last month, but it's going to cost him a lot more, because the interest rate more than doubled.

And so then you would say, well, maybe they can't buy it, because all of a sudden their debt to income ratio might be thrown out of whack.

Exactly. So all of a sudden they can't buy a 500 000 house, maybe they can only get three hundred thousand. What I'm describing is a repricing of assets, Roger. So if there's not enough people that can buy the half million dollar house, that seller might have to lower their price, and that's what we're seeing right now, is a repricing of assets. As the cost of money goes up, asset prices come down.

That is no different than what we're seeing in the stock market. So as companies have a harder time making their earnings, their asset price gets lowered, so the stock price comes down, and as that comes down, assets are going to be repriced. They've been repriced. I think you said the market's off 20, S&P, so S&P 500 off 20 year to date. That's a big move. I don't know that that's all of what we're going to see in terms of asset repricing.

And the reason I say that is because I don't think the Fed has completed its raising of the interest rate, and the reason I don't think they have is because inflation versus where they want inflation, there's quite a gap there, right? And to bring that down to their two or even three percent range, we've got to slow spending a lot more to get us there, and that means more interest rate hikes. And interest rate hikes, every time that occurs, you get a repricing of the assets. That's going to be challenging.

And so then, of course, everybody wants to know, well, how much are they going to raise rates in 2023? I don't know, but I think somewhere around the five handle is where they finally get what they want. But who knows, it could go more than that, and the higher it goes, the more we get a repricing of assets.

Stock market may be on sale today, and if you're a long-term investor, I would tell you, stick with long-term investing and put some money to work. But if you're concerned about your horizon, if you don't have 10 or 15 years, you might want to keep some cash on the sidelines, Roger, because I believe asset prices can easily come down based on interest rates going up.

And so this becomes a stock picker's market, meaning you've got to know what sectors of the market are going to do well coming or going into a recession and coming out of one.

Correct.

And we've done some podcasts in the past. We've talked about different ways to enter the market, some strategies that we use and some others can use, such as using a selling put strategy to get in stocks at a discount, using covered call to give you some protection. I think it's very important right now, because there is so much going on, I highly encourage you to find a financial advisor, financial professional, talk to them, because this is a time where emotions can take over, and there's gonna be a fear of missing out when the market starts to bounce, and there's gonna be a fear of losing it all when the market goes down. So these are very tough times, in my opinion, for emotional investing.

You ask about some of the mistakes that people make. Well, one of them is what you're talking about a little bit. It's the FOMO, right? Fear of missing out. So all of a sudden they think, my goodness, the market's recovering. That just happened a few weeks ago, Roger. The market all of a sudden started going up again, and people started jumping in. We saw a lot of what I call the stupid money trying to catch this thing, thinking it's going up, and then all of a sudden we're back. It turned around on them. And the market was only down 16 percent at the time, so we've come back another four percent, and whoever bought in, that was an immediate four percent loss. So stupid money unfortunately can drive the market up, and then short sellers can drive it up. Those things lead people to mistakes.

But one of the cardinal sins is holding too much cash. And then when you hold it, the unfortunate part is then it starts to burn a hole in your pocket, right? And when it does, then you start jumping in because you think you've got it right, and chances are you don't. It's simply that you're monitoring what your friends are doing, or you've got the FOMO thing going on, and you start pushing it in. Holding too much cash, big mistake in a lot of cases.

Inflation, another huge component to making mistakes. When we have a lot of inflation, folks get really scared. That's what drives them to cash. On the other hand, you have to be careful with holding all that cash, because inflation cuts into your spending ability, or rather your purchasing power, of that cash.

Some would argue, well, I don't want to be in stock if they're going to fall, and others would say, yeah, but you don't want to be in cash because your purchasing power is eroding. And I think there's a combination there, but you never want to be on the sidelines, simply because the markets can recover quickly. You also don't want to miss dividend opportunities. A lot of things are important there, but there's got to be the right balance, and a lot of that depends on who you are and what your goals are and what your time frame is for investing.

Exactly. I think it's very important during these times to have income producing assets. Some people might have a rental income from a rental house. The house can go up and down in value, but you're still generating cash flow to spend. Same with high dividend paying stocks. Yes, they may go up and down in value, but a lot of them are a lot lower now than they were, the yields are a lot higher, so you can get some income while you wait for those stocks to turn around. But when you get that cash flow, that helps offset the high inflation rate, because now you have extra cash coming in to offset that.

Another good thing about at least holding cash now, or holding some cash like you said, is at least now we're getting some interest rates on it. Our money market rates are a lot higher than they were. A year ago, year and a half ago, you literally made nothing sitting in cash. At least now we can earn two and a half, three percent being in cash, and CDs are paying a good rate. I know you've been using those a lot in some of our portfolios.

Two-year Treasuries, one-year Treasuries, short paper is doing well.

Yep.

Right, we're getting some lift out of that part of the market, so that makes it a little better as it relates to holding cash.

The other thing I was going to add, Roger, is when we're thinking about allocation and how to invest, one of your questions early in the show was, what should investors do in 2023? I think what you just hit on is so important, and I just want to touch on that for a minute. I think hard assets, real estate, things that pay, so passive investing or passive income, so rental income, I think is a great thing. Be careful how you're buying that real estate, because a lot of prices are still elevated. Hard assets are something that the Federal Reserve's moves don't generally affect as much. In other words, the cash flow on those is generally pretty good.

Fiat currency, crypto coin, I think those are high risk assets at this point. Crypto, to be sure. We talked about it last week. I don't think the volatility's gone by a long shot. Now, some people would say get in it now because we think the value is 250 000 a coin. Maybe, but let's not forget it was trading at seventy thousand a coin a year ago, right? It's down 80 percent. So if you believe that it's a hedge and you're okay with that kind of volatility, by all means go to the deep end of the pool. But you heard it here, be careful, because crypto and all blockchain currencies, very high risk.

I would be thinking about reducing my exposure to high growth stocks as we are in this rising interest rate environment. It's going to be hard for them, because cost of capital is going up, and those assets get repriced faster than others. Technology, I think, is still in the woods, and so be careful. Certain sectors will do well as we begin to pull through all of this, but in the meantime, we're going to see continued carnage in certain sectors of the market, and other sectors will perform much better. There's always a bull market, but you better know where to find it. In this case, there's a lot of bear markets that you have to be very, very careful of. They'll jump up and bite you when you least expect it.

Absolutely. And one other thing for our viewers, too: there are some things you can do in this down market. Tax loss harvesting. If you're investing in a taxable account, meaning it's not an IRA, it's not a 401k, and you have losses in your positions, you may want to take those losses. You can take those to offset your gains. You can use an extra 3000 offset income. The good news is, if you have more losses than that, they roll, so you can push those losses into the next year, the year after that. Those never expire until they're actually used. Note, though, if you sell something for a loss, you may

not replace it for 31 days with the same equity. Now, you can buy something that's like kind. For example, when most people use, you could sell Home Depot and buy Lowe's, for example. Same type of stock, not the same company, but you could take the loss in Home Depot and now own Lowe's.

So look through your portfolio if you have any losses on stocks. Just make sure, though, if they're dividend-paying stock and they're still going ex-dividend this December, wait till after the day it goes ex-dividend, sell the stock, and then turn around and buy something else, or hold it in cash for 31 days and then repurchase that stock, this one you really want to own.

Get that dividend and take advantage of the harvesting, is what you're saying.

Correct. So just a couple more things, Roger. One, employer stock. Huge mistake right now. People are buying lots and lots of their employer stock. I think being concentrated in employer stock, or any stock position for that matter, it can be a dangerous way to invest, particularly in this environment when asset prices are being adjusted based on cost of money. Okay?

And as that continues, those asset prices can get repriced quickly. And when you're concentrated in a position, if you've got 30 or 40 or 50 percent of your portfolio in one stock and all of a sudden those assets get repriced, you are going to feel that pain in a huge way. So don't forget, being diversified is incredibly important to avoid some of the incredible shocks that occur when markets are doing what they've been doing and what they likely will continue to do in 2023.

And the other thing I want to mention, Roger, is emotional attachment. I see it all the time. People, "Oh, I've just held this one so long," or, "Well, I just really love that stock." Don't invest that way. If you're investing based on emotion because you just feel like you should hold that stock, after 30 plus years of this, I can tell you that when you let your emotions guide your decisions when it comes to stock buying and selling, your emotions don't stand a chance of winning more than they will lose.

Well, Phil, really do appreciate you taking the time to talk to this evening. I think we cover a lot of great topics here. Again, we'll have another one on another podcast soon on the second part to the FTX scandal. Can't wait for that, because it's going to get big.

It's already big. Be careful out there in crypto land. There's a lot more to come, I'm afraid, based on that FTX trade.

Thank you guys for tuning in this week. Please check us out on social media. We're on Instagram, LinkedIn, Facebook. Please like us, please subscribe to our channels, and we look forward to seeing you again next time. Till then, God bless America. Have a great day.