Investment community rumors about an upcoming recession. What will cause it? And How to pretect our day trading? We give you our explanation
In recent months, the talk in the investment community has been about the upcoming recession. Reports from various investment banks point to one happening in 2020. This has been ‘confirmed’ by the recent inversion of the yield curve (you can find here an useful explanation). When this inversion happens, the yields on the short-term bonds rise above those of the long-term government bonds. This article explains what causes recessions and how to be protected.
What causes recessions: a common Misconception
A common misconception among many market watchers is that recessions happen as a result of the general economic growth. They opine that asset prices like stocks, bonds, and real estate rises when the economy is expanding and decline when the economy is weakening. This thinking is usually flawed, if you consider what has caused the previous recessions.
In the 1990s, the Federal Reserve left interest rates so low to deal with the Asian currency crisis. This was a period in which a crisis in the East and Southeast. The crisis started in Thailand, with the collapse of the Thai Baht as a result of lack of a foreign currency. As this happened, other Asian currencies like those of Japan, Indonesia, and South Korea were the most affected. They were followed by Hong Kong, Philippines, and Malaysia. To prevent the contagion, the Federal Reserve lowered interest rates. As this happened, investors appetite for risk increased in the US and most of them started to invest in risky assets like new technology companies. Ultimately, this ended in early 2000 when the dot com bubble burst. The dot com bubble led to a global recession as asset prices declined.
After the dot com bubble, the Federal Reserve lowered interest rates sharply. The bank always does this with the goal of attracting more capital to the financial market. As a result of the lose monetary policy, banks started selling credit in large scale. This happened because of the new products, which included the credit default swaps, CDOs, and MBs. As the Fed started raising interest rates, the delinquencies in the housing sector started piling up. Ultimately, the bubble burst in 2008.
Where we are now
After the financial crisis, the Federal Reserve lowered interest rates to boost growth. The bank also brought new monetary policy methods known as quantitative easing to boost the economy. These expansionary policies ended in 2015, when the Fed started hiking interest rates. Over these years, these low interest rates have led to a surge in student debt, housing debt, auto loans, and most importantly, corporate debt. The latter has grown from below $5 trillion to above $9 trillion. Sadly, most of these funds have gone to dividends and share repurchases. This could be the main cause of the next financial crisis and it will hurt most Americans because the source of credit has been the large pension funds.
See also how next recessions probably happens
How to stay protected
As a trader, you will not be affected a lot by a financial crisis. This is because you make money by making short-term trades in diverse assets like stocks and currencies. You are not an investor, who stays invested at all times. Stull, to protect yourself from the adverse effects of a global meltdown, you need to practice safe trading, which means being less over-leveraged and always having a stop loss on all your trades.
You may consider to read also Five Easy Trading New Years Resolutions You Should Consider