Recession guide: What is it, and how could it affect your finances?

What is a recession?

When you think of a recession, you probably think of job losses and the economy slumping. These are some of the signs, but there are actually many factors that determine if we are on the verge of a recession.

When a country’s economy is slowing down, and the gross domestic product (GDP) drops, this is generally a signal of a recession. This usually results in reduced consumer and business spending, plus higher unemployment.

Similarly, individual income and industrial production are also important factors. For instance, your income may decrease if you lose your primary job, or your dollar won’t be able to go as far if your salary doesn’t increase with inflation. If incomes are lower across the board, that is one sign of a looming recession.

In Canada the authority on when a recession hits is the C.D. Howe Institute Business Cycle Council. They meet yearly — or when it looks like Canada might be entering or leaving recession — to examine the current financial situation and provide guidance to policymakers.

What are they looking for? A period of “pronounced, persistent, and pervasive decline in aggregate economic activity.” This downturn in must last at least three months for it to be deemed a recession, but there are a number of factors that go into the definition.

If unemployment is high, but the GDP is performing well and inflation is low, it would not be a recession.

CD Howe has five categories to rank the severity of recessions. Category one means the recession is “short, mild” with no decline in quarterly unemployment. With a category five, the GDP and employment are reduced rapidly, and the decline lasts for over a year.

In the graph below, you’ll notice that there are peaks (high points) and troughs (low points). The period of expansion is between the trough and the peak. This is when the economy is growing. A recession is the opposite, the period between the peak and the trough, when the economy is shrinking.

As you can see in the graph, a business cycle consists of waves. It naturally rises to a peak. As it moves from the peak to the trough (the lowest point), the period is called a recession. As the economy expands, it is a period of recovery. One full business cycle consists of both a period of recession and expansion, as the economy moves from peak to peak.

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Causes of a recession

When the economy is expanding, it’s nothing but blue skies and clear sailing.

When there’s a lot of turbulence in the economy, you might be headed for a recession. For instance, if there is a rise in unemployment, a lower gross domestic product, decrease in consumer spending, and higher interest rates, it could be a catastrophic economic cocktail.

The Bank of Canada targets between 1% to 3% inflation in order to keep the economy healthy and balanced. The ideal amount is 2%.

The Bank of Canada has been raising interest rates steadily through 2022 and into 2023 in response to inflation and the economy growing too quickly.

Raising interest rates discourages people and businesses from borrowing money, leading to less spending and therefore slower economic growth.

Higher interest rates can also lead to job loss due to fewer new jobs being created, and a reduction of corporate and individual spending.

On the flip side, if the economy is too slow to grow, the government may spend more in order to encourage consumer spending. For instance, the Bank of Canada may keep interest rates low - an act that encourages individuals to borrow and spend money. They may also issue stimulus cheques that allow people to spend more than they normally would.

Canada’s recession history

Canada has experienced 10 recessions since the Second World War, with five occurring since the 1970s. The most recent was in February 2020, with its lowest point being in April 2020.

The longest was during the Great Depression, lasting from April 1929 to February 1933. Since then, the longest recession in your lifetime was from March 1990 to May 1992.

The recession of 2020 was short-lived and had a rapid recovery. But this quick bounce back also came with supply chain disruptions, as demand was outweighing supply. In part, this was a result of continued labour shortages along with increased consumer consumption of goods.

With low interest rates, consumers and businesses were encouraged to spend more, but the supply levels couldn’t keep up.

Historically, the recession of 2020 was an unprecedented confluence of events. The economy was able to surge back to life with the help of strategic government spending, and simultaneous business recovery.

During the Great Recession of 2008-2009, there was a similar global economic slowdown;, where there was a direct impact on foreign trade and international financial markets were weakened.

In the U.S., the subprime mortgage crisis was a major contributor to the global recession, and the impact was immediately felt in Canada. As Jean Bolvin, former deputy governor of the Bank of Canada, said at the time, “Since three-quarters of our exports are destined for markets in the United States, experience taught us that when the United States sneezes, Canada catches a cold.”

Because there was such a significant drop in exports, the onslaught of the recession was fast. Despite this, the economic recovery was also much faster than previous recessions.

Bolvin observed that a significant factor in the economic recovery was household and government spending. With Canada offering rich natural resources that are in-demand,we had everything in place for a quick recovery.

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Is Canada in a recession right now?

The CD Howe Institute states that a recession is imminent. But not all indicators are pointing towards it.

One of the indicators is high unemployment. If one were to look at this as the only indication of a recession, then Canada wouldn’t be anywhere close.

According to Statistics Canada, employment rose by 0.5% in December 2022, adding 104,000 jobs to the economy. The unemployment rate was at 5%, which was only slightly greater than the record low of 4.9% seen earlier in the year.

However, the real estate sector plays a large role in the economy. Higher mortgage rates have led to less spending in the housing market, which suggests a forthcoming recession.

“Our resources sector plays a big role in the economy, as does our real estate and construction sectors,” said Jeremy Kronick, director of monetary and financial services research at C.D. Howe Institute.

Because there is significant debt in the housing and corporate sectors, they are much more likely to feel the impact of the rate increases.

Kronick notes that because real estate plays a significant part in the economy — it will exacerbate the recession since there will be a significant fall in demand and price.

Because of the debt load carried by corporations and the high interest rates, a recession is all but inevitable in 2023.

“This recession is happening because the Bank of Canada needs to bring demand back in line with supply,” said Kronick. “The unknown is how much of the negative supply shocks can be unwound so that the drop in demand is minimized.”

Recession outlook 2023

The present economic climate seems ready for a recession. With interest rates rising and the economy slowing down as a result, many factors are in place that indicate a recession is all but guaranteed.

“We do have a recession in the forecast,” said Benjamin Reitzes, Canadian rates and macro strategist at BMO capital markets. “The timing of it, though, is becoming a little more uncertain.”

Because employment numbers are still strong and there is solid wage growth, it is possible that a 2023 recession won’t be as deep or as prolonged as some in the past.

Industries that rely on low interest rates, like real estate, construction and tech industries, will feel the brunt of the recession, says Kronick.

“The rate hikes are pretty severe given levels of indebtedness.”

Kronick says that if supply does improve, interest rates can begin to come down to help minimize the damage on those carrying significant debt. Similarly, he anticipates that as employment slows, inflation will begin to ease off.

Leslie Preston, managing director and senior economist at TD Bank, said “our forecast is more for a period of stagnation in Canada, as the impact of higher interest rates and high inflation weigh on consumers and businesses and, and demand softens.”

“We do think that a period of very soft growth is required to bring inflation back into more manageable levels.”

How to prepare for a recession

The idea of a recession can be scary. You may be concerned about your job, or what your finances will look like during the dip.

The effects of inflation are already being felt. Everyday we’re seeing rising fuel costs and our dollar having less buying power at the grocery store.

Having your finances in order can help ease the impact of a recession, so it’s important to prepare yourself for what may come.

• Prepare a budget.

Lay out your expenses in front of you and take a good look at them. Identify where your money is going, and see where you can trim some expenses.

Figure out your financial priorities. Do you have unavoidable expenses? Would you rather save for your children’s education than set aside money for retirement?

Take stock of your finances, and ensure you know how much cash you have available in case you need it. If you have life events coming up (e.g. having a child), make sure you’re financially ready for them.

• Start an emergency fund.

You don’t want to think about the possibility of losing your job, but you never know what might happen. An emergency fund or sinking fund ensures you’re ready to weather whatever storm you may face.

“[Have] those in place first…otherwise, you'll constantly find yourself stuck in that cycle of debt,” says Parween Mander, a certified credit financial counselor and trauma facilitator.

It’s recommended to have an emergency fund that covers three to six months of expenses. It might feel that saving that much is impossible, but it’s important to save what you can. To help you save, open up a secondary bank account, and set aside what money you can now.

• Prioritize your debts.

The more debt you have, the harder it is to get out of. If you anticipate having less income or face unemployment due to a recession, debt can be crippling. And with interest rates rising, a few missed payments can make it impossible to catch up.

You can ease your woes by consolidating your debts, which usually lets you pay back at a lower interest rate. Consolidating refers to bringing all your debt (e.g. from multiple credit cards) to one source. If you have debt on a high-interest credit card, consider transferring it to a card (or credit line) with less interest. You could also consolidate under your home equity line of credit (HELOC).

You can always contact your loan provider to see if they offer any conditions that will make your loan repayment easier.

• Limit your spending.

Reducing expenses helps you prepare for tough times, and helps build your emergency fund. Don’t make any big or luxury purchases, especially if you’re concerned about your employment stability. Be sure not to take on any unnecessary loans, and avoid adding debt to your credit card.

• Keep your resume up-to-date.

Take time to update your résumé with recent work experience while you’re employed. Make sure to note any recent accomplishments or job milestones on your social media as well, as this can attract recruiters.

The best time to search for a new job is when you’re employed. If you’re nervous about losing your job, start sending out resumes. Be sure to use your personal and professional connections as well, as these can open unexpected doors to job opportunities.

• Get a side hustle.

Doing freelance work or driving for a ride sharing company on the side can supplement your income when times are tight. This is also a great way to boost your emergency fund quickly.

• Don’t panic.

It’s tempting to react and make impulsive decisions when signs of a recession start to show. Before you make any major moves — especially those that impact your finances — take a step back and consider what consequences the actions could have.

It might seem like it’s a good idea to sell all your stocks, or that refinancing your mortgage is your best course of action, but be certain that you understand the impact these decisions will have. If you can, speak with a fee-only financial advisor who can give you professional guidance about how to prepare your finances for the future.

Recession-proofing your investments

Recessions might mean that you have to stretch your dollar further, but at the same time they provide an opportunity to make some strong returns with careful investing.

Here are some ways to protect your money through investment during a recession: Buy low and sell high: We’ve all heard the golden rule of investing. And there’s reason behind the wisdom. You never know when the true bottom of the dip will be, so buying in a recession can provide great opportunities to get in the investment door.

• You might consider fractional investing in major companies.

Some fractional investing companies allow you to invest in stocks, or assets such as real estate, at a reduced price. This will let you get a piece of the action without draining your finances.

• Alternative investments.

There’s more than one way to invest your money. Hard assets are a great way to diversify your portfolio — and are an investment favoured by big names like Bill Gates and Robert Kiyosaki. Gates, Jeff Bezos and Warren Buffett are all big investors in farmland. Other hard assets worth considering are art and gold.

Recession resistant areas to consider investing in:

• Consumer staples.

Defensive stocks like consumer staples, are reliable and can help weather the storm of recessions.

They’re a sound investment choice since things like food and drinks, household goods, and hygiene products will always be in demand. Manufacturers might take a hit during a recession, but chances are strong that they’ll continue to move products and bounce back quickly when it’s over.

• Utilities.

Investing in utilities can provide stability during downturns. By investing in utilities, you can follow in the footsteps of Mike Wilson, stock chief of Morgan Stanley. Electricity, water, natural gas, and other essential services are recession-resistant sectors to consider.

• Health care.

Health care is always going to be a necessity. It’s an area that sees plenty of innovation. With Canada’s aging population, it provides an almost guaranteed return on investment.

Healthcare ETFs are a great way for people with limited knowledge of the sector to get into the market

• Real estate.

It comes with a high price to get into the market, but people will always need a home. If you have the capital, an investment property can provide you with regular income. On top of this, when you’re ready to sell, you usually make a nice return on your investment.

Commercial real estate also offers an opportunity to invest in property. However, you need to be sure that you’re familiar with the risks involved in such a venture, and do your research before jumping in.