6 Signs We’re In a Market Bubble

In The Big Short, there’s a scene where Michael Burry (Christian Bale) is confronted by two of his biggest clients over Burry’s claim of a housing bubble. The first client, Lawrence, tells Burry that “actually, no one can see a bubble. That’s what makes it a bubble.” Burry responds: “That’s dumb…there’s always markers.”

It’s true. There are always indicators, as history has shown. We are currently in the midst of the longest running bull market in history, going all the way back to March 9, 2009. Last February began a large, COVID-induced selloff that corrected course by summer and actually put the market in the green by the end of the year. It was the first time ever a market dropped by 30% and ended green in the same year.

So are we on the verge of the next “Big One?” Here’s five reasons that say we are.

1. Wrong Side of History

As mentioned, we are currently in the longest running bull market of all time. Prior to the 2009-to-present run, the longest was the 1990s, which ran for 113 months. Our current run is at 143 months. Market commentators called last year’s 30% drop the “end of the bull market” but because it came immediately back and then broke the old high I do not consider it the end of the market run. The correction was hefty, but the long term trend line was not broken.

Looking at the list above, prior to our current run starting in 2009, the average bull market lasted 56.83 months. The current run is nearly three times that. Not only that, but the S&P percent change if you include 2020 and 2021 is up to 437.54% taking out the old record from the Roaring 90s.

Simply put, we’re far overdue for an ending to this bull market.

2. Margin Debt is at a Record High

Margin is the difference between the total value of the investment and the amount you borrow from a broker. Basically, you’re using cash or securities you already own as collateral to make more investments in hopes of making a profit. As with other loans, you have to pay back the money you borrowed plus interest. But margin trading comes with risks. If the amount you borrowed gets too large relative to the value of your securities, you will have to deposit more funds. Otherwise, your broker may sell off some of your assets. And remember, even if you lose your entire investment, you’ll still have to repay what you borrowed, with interest.

Website for Robinhood

Any investment bought via credit always runs the risk of margin calls and, eventually, liquidation.

Barry Ritholtz

Margin debt in 2020 reached a record high. Advisor Perspectives has compiled the amount of outstanding margin debt in the S&P 500. The correlation between the amount of debt and the S&P 500 level is not an accident; after all, buying stocks on credit allows you to buy more than you could just on cash alone. By borrowing money from a bank or brokerage to buy stocks (in hopes they go up), funds and investors drive up the market.

The expansion of credit also correlates with past bubbles (and crashes) in the market: the dot com bubble of the late 90s, the housing crash starting in late 2007, and the sharp drawdown in 2020. However, in Jan 2021, the outstanding margin is higher than it’s ever been, lost to the point of going parabolic. The chart below gives a better illustration as to the growing debt burden (or negative credit) overall in the market:

Margin can only expand so far. A bank or brokerage will only lend so much before either the servicing payments or interest becomes too great. There’s also the possibility that a drop in price will precipitate a margin call and the brokerage has the legal power to start selling securities in your account to repay loans. The risk at that point becomes systemic, with multiple brokerages liquidating accounts to get their money back.

For example: I have $100 and I buy 5 shares of AT&T (T). The shares go up in value. I can then use them as collateral to borrow another $100 from my brokerage to buy more shares of T. It goes up, so I borrow another $100 to buy more, and so on. My parents did this during the housing boom in the 2000s: take out a home equity loan to improve the house. The value of the house went up, so the line of credit in the home equity went up, so more could be borrowed for more improvements…and so on. So in my brokerage account, I have over $300 in T stock, only $100 of which was my own money. If T’s stock price drops, the value of the collateral drops, so I get margin called. Worse, if it drops below the price I bought it with my original $100, I could be wiped out. I owe the brokerage $200 regardless, so if all the shares I bought are sold for $200, I have no money left and no shares.

Total wipeout.

Margin debt relies on the “greater fool” theory that pervades every stock market bubble. Essentially, I’m willing to take on the risk of borrowing money to buy stock because I believe there will always be someone (a “greater fool”) to buy it from me. Eventually, there wont be any buyers because prices will reach a point where no one wants (or can) afford a stock. Now you’re stuck with stock quickly losing value that you bought with credit. And if everybody holding that stock tries to sell at the same time or is forced to sell via margin call…well it turns into a landslide.

According to the Financial Industry Regulatory Authority, outstanding margin debt at the end of 2020 was $778.04 billion.

3. Record New IPOs

Jordan Belfort Takes Steve Madden Public in The Wolf of Wall Street (2013)

An Initial Public Offering, or IPO, is when a private company “goes public” by offering shares of the company on the stock market. It is the late stage of start ups: venture capitalists or investors invest money into a company (or person) with an idea, build the company up until it’s functioning and offering a product or service, then sell it via IPO, recouping their investment plus profit. Imagine investing in Apple or Tesla before it went public, then being able to sell off your shares of the company at big returns.

Large amounts of IPOs are also generally seen as a market top or bubble — just look at the dot com craze of the late 90s. Internet startups were dropping shares all over the NASDAQ, with investors desperate to grab anything with “internet” or “dot com” in the name. It eventually became a racket — companies like pets.com that had no real business model or even revenue were being sold to the public.

And now it’s happening again.

In 2018, the number of IPOs of companies with negative earnings (i.e., don’t make money) reached 81%, which happened to be the same ratio in 2000, when the dot com bubble burst. In 2020, the trend only continued. As InsideHook put it in an article titled “Stock Market Mirrors Dot-Com Bubble as IPOs Mysteriously Skyrocket”: “Why are unprofitable tech companies soaring during a pandemic?

According to the Wall Street Journal article “Record IPO Surge Set to Roll On in 2021”:

Defying expectations, investors piled into initial public offerings at a record rate in 2020, and few expect the euphoria to wear off soon.

Companies raised $167.2 billion through 454 offerings on U.S. exchanges this year through Dec. 24, compared with the previous full-year record of $107.9 billion at the height of the dot-com boom in 1999, according to Dealogic.

The coronavirus pandemic turned the typical rhythm of the IPO market on its head, with $67.3 billion raised in the fourth quarter. That amount is roughly six times the total for the first three months of the year.

A lot of this could be driven by retail investors over the course of last year. Axios calls this “The Robinhood effect.” If you recall in my last post titled “Gamestonk,” retail investors (more on them in a minute) dove headfirst into trading stocks using stimulus checks and Federal unemployment bonuses to buy up companies like Tesla.

Even as I write this, the IPO for dating-app Bumble just opened 77% higher than it’s IPO price on its first day of trading. The app disclosed 2.4 million paying users as of September 2020, but also a net loss of $84.1 million…with a net loss margin of 22.3%. With it’s current stock price, the dating app company is valued at $14 billion.

Make no mistake — this is mania. Retail traders are buying shares in IPOs of companies they recognize: AirBnB, Uber, Lyft, Pinterest, and Slack. These are apps and software they know. And they all want to get in on the ground floor in case the stock is the next Tesla or Apple. Just like people didn’t want to miss out on pets.com being the next…well, whatever. Perhaps even more maniacal is the ubiquity of SPACs or “Special Purpose Acquisition Company.” Without going too far down the rabbit hole, here’s The New York Times’s definition: “

These vehicles have only one purpose: to find a private company and buy it, usually within two years. SPACs are sometimes known as “blank check” companies — as in, investors give them a blank check to go buy a business, sight unseen.

Those checks are getting bigger and bigger, with SPACs raising nearly $26 billion in January, a monthly record in an already red-hot market.

As the Times article also asks, “What could go wrong?

4. Crazy P/E Ratios

In case you don’t know what a P/E ratio is, I threw out the formula from the get go. More bluntly, it’s the measurement of how far from reality a company’s stock is. If a company that has 1,000,000 shares makes $2,000,000 than its earnings per share (EPS) is $2.00. Now the same company’s stock is $200/share. So $20 divided by $2.00 is a P/E of 10. Therefore, the higher the share price (or lower the earnings per share), the higher the P/E. A P/E of 10 means it would take 10 years to earn back your initial investment through company profits. Another way of looking at it is, people are willing to pay $10 for every $1 a company earns.

This little bit of math is important to understand the impact of a runaway P/E. For the most part, P/E is used as a way to compare valuations between companies. A company with a P/E of 20 might be not be seen as overbought as a company with a P/E of 50. Remember, a P/E of 50 means it would take 50 years to earn back your initial investment through company profits.

Now take a popular stock like Tesla (TSLA), that had a huge run last year due to retail investment interest and cheerleading by ARK’s Cathy Wood. It’s current P/E ratio is 1,268.

If you bought Tesla right now, it would take you over twelve hundred years to earn back your initial investment through Tesla’s profits. Other stocks like Shopify (SHOP) and Square (SQ) have current (as of time of this writing) P/E ratios of 900 and 413, respectively. As a point of reference, a P/E in the mid-20s is traditionally considered “high”. These stocks have become detached from any real financials.

Now expand P/E to the entire stock market, where you aggregate all the companies’ P/E to determine the market P/E. The historical average P/E for the S&P 500 is between 13 and 15. The current P/E for the S&P 500 is 39.87.

For long term P/E analysis, a lot of companies will use something called CAPE — Cyclically Adjusted Price Earnings — or “Shiller PE”. This is the price of a stock divided by the average earnings of the last 10 years. It’s a better way of showing trend over time. Here is the the Shiller PE ratio going back several decades (courtesy of longtermtrends.net):

A December 2020 S&P Global article points out that the market P/E CAPE ratio has now just crossed the 1929 pre-crash level:

The cyclically adjusted price-to-earnings, or CAPE, ratio for the S&P 500 hit 33.1 in November, above the 32.6 level it was at in September 1929, the month before the crash that preceded the Great Depression.

“The fact that we’re beyond the September 1929 levels is obviously an important milestone, and will only add to concerns that current US equity valuations have become disconnected from real economic performance,” Jim Reid, a research strategist with Deutsche Bank, wrote in a note.

To be fair, the article also chalks some of the frothiness “was dismissed by some equity analysts due to the uncertainty of the coronavirus and its impact on forward guidance from companies.” But there’s no denying P/E ratios — like Tesla — are certainly overvalued.

5. Rise of the Retail Investor

“Early in 1928, the nature of the boom changed. The mass escape into make-believe, so much a part of the true speculative orgy, started in earnest.”

John Kenneth Galbraith

I covered a good portion of the boom of the retail investors in 2020 in my Gamestonk post two weeks ago. As of July 2020, retail investors made up over 20% of the entire stock market, fueled by stimulus checks and unemployment bonuses. This was up from 10% only a year prior. A retail investor is defined as someone who buys and sells stock for themselves and not for an entity, fund, or organization.

Global X published an article in October 2020 called “The Renewed Rise of the Retail Investor” and highlighted a key component of the retail investor boom: leverage.

A growing trend within the retail community is the use of leverage to enhance returns. A Yahoo Finance/Harris poll found that 43% of respondents have used margin, options or both since the beginning of the pandemic.19 Traditionally, investors use margin to enhance the returns of small-gain strategies. But it seems that many inexperienced traders today want to supercharge already highly volatile portfolios, bringing them closer to the gains they desire.

Clients are regularly denied access to margin and options strategies due to their inexperience. This wasn’t the case with Robinhood, where higher-level options access originally required a high risk tolerance profile and a certain number of options trades entered on the platform.20 This progression-based system encouraged traders to increase their options activity while potentially overlooking the education component necessary for responsible use. The firm has since updated their options offering, increasing eligibility requirements and educational content.21

Investing can seem easy for the uninitiated when the market’s surging. This makes sense when all you’ve seen is a strong bull market, punctuated by quick pullbacks, over the last decade or so. In this environment, mistaking luck for skill is easy…

Long story short, there’s a party going on right now in Robinhood with loose credit and unchecked greed from inexperienced traders. This sounds exactly like the Investopedia definition of “euphoria”, which occurs in a bubble environment before ‘smart money’ begins profit-taking. “Caution is thrown to the wind as asset prices skyrocket.” It also reeks of pre-crash 1929, with retail investors taking out loans to buy stocks. Financial Times recently published an articled titled “Investor Anxiety Mounts Over Prospect of Stock Market ‘Bubble'”, noting that the rise of “inexperienced amateurs as a particular concern.”

As the old Wall Street maxim goes, the trader on the street is the last one in and the last one out.

The combination of inexperience, high leverage, and total risk aversion is what usually leads the herd to drive the bubble to the point of popping, usually when the credit runs out. There’s also another big obstacle coming in the next 60 days…

A lot of these ‘newly minted’ retail traders starting buying stocks during 2020’s pandemic lockdown out of boredom and checks coming in from the government. With the surge in the market last year, a lot of the common-name stocks saw profits. Now those same retail traders are going to owe capital gains taxes on any profits realized — and given so many of them were short-term investments (owned one-year or less) they’re taxed at ordinary income rates. With the tax bill for 2020’s investing gains due, traders may have to sell current stocks to pay the tax bill. Given that so many Robinhood traders last year were new to buying stocks, they may not be fully versed on how capital gains tax works, and could be in for a shock.

But it’s not over yet.

For those who lost their job or were furloughed and received the $600 weekly unemployment bonus from the Federal government, those checks are also taxed. For a lot of these pandemic stock traders, huge tax bills could be coming. Some may be aware, others may not. As of May 2020, 20 million Americans were receiving the extra $600 Federal unemployment bonus — most of them on the hook for income tax on money collected. With an unexpected tax bill, a lot of these novice retail investors may look to start selling stocks (taking further short-term profits that will be taxed for 2021) to cover tax bills. Remember, these retail investors currently make up over 20% of the stock market. If a large portion begin to sell to cover taxes, well…

The fuse is lit.

6. Companies Pressured into Debt

Last week Bloomberg noted that companies were being pushed towards taking out more debt due to demand in Junk bonds. In “Junk Buyers Desperate For Debt Are Pressing Companies to Borrow,” the authors call to attention the huge demand for “junk bonds and leveraged debt” that investors want to buy up. Junk bonds are typically considered risky, which is why they pay higher yields (junk bonds are also known as “high yield” bonds). The fact that junk bonds are in such demand means investors are clamoring for high yield or better returns on their investments. This means money managers need to keep issuing new junk bonds to meet demand. And to issue a junk bond, a company needs to borrow money — a shaky company that is at risk to justify the high yield.

This likely means companies that probably shouldn’t be going further into debt are being pressured to go further into debt so money managers can sell their junk bond.

This seems freakishly similar to the housing boom, when banks were offering NINJA (no income, no job verification application) loans just to get the mortgages so they could sell them off. Mortgages were being sold to buyers who were unlikely to afford them, or buyers who already had one or more mortgages on other properties. Cue that other scene in The Big Short:

“I own five houses. And a condo.”

Eventually, risky companies are going to be saddled up with debt payments, and it only takes one or two of them to be unable to make payments and the junk bond is defaulted on.

Honorable Mention: The Buffet Indicator

What kind of post would this be if I didn’t mention America’s favorite investor? The ‘Buffet Indicator’ is a ratio favored by Warren Buffet; simply defined as the entire value of the stock market divided by the U.S. Gross Domestic Product (GDP). The idea is to see how the stock market measures in relation to the country’s economy: a ratio of 1 would be a stock market in parity with economy, basically comfortably supported by the products and services of the nation. To measure the ratio, Buffet likes to take the Wilshire 5000 Total Market Index and divided by the most recent quarter GDP number. Buffet himself calls this “probably the single best measure of where valuations stand at any given moment.”

The Buffet Indicator just hit a record high of 195% this past week.

If you look at the chart above, you can see just how far the ratio has pulled away. In the dot com crash of 2000 and the housing bubble of 2007-2008 the indicator isn’t even close where where it is now. The recent parabolic spike comes as no surprise either — lockdowns and COVID-19 have impacted the service and travel industries, reducing the GDP. But the market continued to go up.

From a February 12, 2021 Bloomberg article:

“It highlights the remarkable mania we are witnessing in the U.S. equity market,” said Michael O’Rourke, chief market strategist at JonesTrading. “Even if one expected those (Fed) policies to be permanent, which they should not be, it still would not justify paying two times the 25-year average for stocks.”

They don’t Buffet the ‘Oracle of Omaha’ for nothing.

I never intended for Quit Your Job to become an investment blog, but investing is a key component to getting out of your soul-crushing 9-to-5 and becoming financially free. Anyone who read my post on Robert Kiyosaki’s Cashflow Quadrant knows the cruciality of the “I” Investor Quadrant. Being an investor means more than buying Apple (AAPL) stock and holding into infinity. You have to know what’s going on in the market, in companies, in economic trends, or you can find yourself wiped out.

And back to the 9-to-5 in no time.

Disclosure: I am not short the market at this time, nor do I have any positions that would benefits from a market drop. I am not a professional investment advisor, nor do I hold any certifications or degrees in finance or economics. I’m just a guy who reads a lot.

Edit: This article was originally published as “5 Signs We’re In a Market Bubble” on February 13, 2021, but after discovering just how high the Buffet Indicator had gotten I wanted to include it in this post. I revised the post from 5 to 6 and added in the BI.

The Word No One is Talking About

Six weeks into lockdown mode, the U.S. economy is a mess. States are just now starting to open back up, but the damage has been done — some of it permanently. The current unemployment rate in the United States is 14.7% and by some calculations (likely the bureau of labor statistic’s U6 measurement), as high as 23.6%, not far from the peak of the Great Depression.

Bankruptcies are beginning to pile up too. In the month of May alone, Neiman Marcus, Gold’s Gym, and J. Crew have filed for bankruptcy and J.C. Penny is considering it (AMC Theaters possibly too). Wall Street believes the vast majority of the 20 plus million Americans jobs lost will only be temporary — but maybe not so with bankruptcies piling on. Even companies that avoided bankruptcy are slashing jobs at a historic rate: Boeing cut 16,000 jobs in April and, according to a coronavirus layoffs calculator site, 375 startup companies have laid off more than 42,000 employees.

Ok, the point is made. Unemployment is breaking out as a bad as the virus. People are losing their sources of income. Jobs are vanishing — temporary or not.

But there’s something else going on that’s headed straight for the unemployment quagmire.

In the six weeks of shutdown due to COVID-19, the Federal Government has spent over $6 trillion. Trillion with a ‘T’. That’s $6,000,000,000,000 — or one trillion dollars per week. $2.4 trillion of that amount comprises four coronavirus relief bills; this includes the CARES Act, SBA Payroll Protection Programs. The remaining money has come directly from the Federal Reserve, who has acted aggressively to stave off economic collapse through numerous programs, including purchasing securities directly. On top of all this, the Fed also reduced bank reserve requirements to zero. This means if you deposit $100 in a bank, they can lend out all $100 of it, keeping none in reserve. This has massive implications — too much to explain here, but watch this to see the impact of reserve requirements in bank lending.

Furthermore, the Fed has also lowered the federal funds rate (the rate banks use to borrow from one another) down near 0%. This rate is used as a benchmark for various other loan rates, reducing the cost of borrowing for mortgages, auto loans, etc. This is the equivalent of turning on the spigot and the handle coming off.

Make no mistake — this is a massive amount of liquidity suddenly appearing out of thin air. The national debt just crossed $25 trillion, and the juice is running. And at the time of this writing, this whole thing is not over. Congress is discussing more stimulus packages. Just today Congress unveiled another coronavirus relief bill (the fifth so far), costing another $3 trillion. No problem — the Fed’s Neel Kashkari says the Fed is going to do “whatever we need to do to make sure the financial system continues to run.”

Sure, what’s another $3 trillion on top of the 6 just minted?

In short, there’s more money coming but not necessarily jobs. So what’s the word no one is talking about?

Stagflation.

An odd little portmanteau of “stagnation” and “inflation.” It is a period of high inflation coupled with economic depression. It’s odd too that no one in the media or government is mentioning it, because it looks exactly where we’re heading: $6 trillion and counting in six weeks coupled with job losses and bankruptcies.

Stagnation is a nasty beast because it’s difficult to resolve. In an inflationary environment, rates can be raised to cut off the spigot of currency expansion and reel in spending — a by product is reductions in borrowing and ‘tightening of the belt’ so to speak. Value returns to the currency. In a stagnation — or deflation — prices are falling and money is hard to come by. Loosening the belt allows money to flow a little easier, lending to be encouraged, which leads to businesses expanding via credit (and hiring).

So what do you do when you have falling employment and rising inflation?

If you ‘tighten the belt’ to choke inflation, it worsens the unemployment and makes it even more difficult for businesses to access credit. The currency may level off, but higher interest rates deepen the deflationary hole. If you ‘loosen the belt’ to make credit easier to obtain (e.g., federal funds rate) to save jobs, inflation gets worse prices go up and you risk a total collapse of the currency a la hyperinflation.

The choice is no win, but the effect felt by the average American is even worse. Job loss or cutbacks result in less income. People are left rubbing nickels together and deciding to pay bills or put food on the table. But in a stagflation, prices are rising due to inflation of the currency and suddenly you can’t afford bills OR to put food on the table. You can’t afford anything and there’s no way to bring in more money with the drag on employment.

The last time stagflation hit the United States was in the 1970s. Core inflation (CPI) was over 5% annually during the back half of the 70s, with unemployment high and an official recession running from November 1973 to March 1975. (As a point of reference, the Fed’s federal funds rate during the 70s was mostly between 5% and 10% — it currently is 0.25% to 0%) To choke off the inflation, Federal Reserve Chairman Paul Volcker raised federal funds rate to near 20%, throwing the U.S. into another recession but alleviating the increasing inflation.

I believe Volcker was a rare breed and no one today would pull the trigger on such a hefty interest rate increase. But there was no COVID-19 lockdown in 1979. With unemployment so high, companies going bankrupt or drawing heavily on available credit, jacking interest rates up would shatter all remaining functional pieces of the economy. To wit, another word has surfaced that people are talking about — NIRP.

NIRP stands for Negative Interest Rate Policy. NIRP is the theoretical physics of economics. A negative interest rate works in theory, but suddenly everything goes to plaid. It goes something like this: If an interest rate is 10%, that is the amount it ‘costs’ to borrow money. A loan of $10,000 would cost you a total of $11,000: the original $10,000 principal plus $1,000 (10%) interest. An interest rate of -10% would (in theory) pay you to borrow money. You would borrow $10,000 and get $1,000 for doing so. An $11,000 loan costs you $10,000.

Up is down. Black is white.

This would greatly increase the velocity of money, as banks essentially got paid to take out loans. The problem is, this cuts both ways. Cash deposited at a bank that previously paid interest now costs money. Your $20,000 life savings earning 1% annually now costs you 1% to leave in the bank. Last year your $20,000 became $20,200. This year under negative interest rates it goes from $20,000 to $19,800. You lost $200 by having it in savings.

The concept behind NIRP becomes searingly obvious — borrow and spend. Who in their right mind would save money with negative interest rates? Who wouldn’t borrow when you get paid to do so. In theory, since mortgage rates are tied to the 10-year Treasury yield, but in theory you would pay back less than you borrowed to take out the mortgage.

NIRP would cause everyone to borrow and spend away savings (why keep it in cash losing money when you can invest it or buy something with it?) But how would this impact things like bank profitability when you’re paying people to take out loans? In a NIRP world, home-owners would refinance to try and take advantage of negative rates which would disrupt interest and mortgage-backed bonds. The whole thing is bizarre.

But in any case, the result would certainly be increased borrowing and spending. Would the Fed actually consider doing NIRP? It’s already being floated in financial circles…

So if the Fed doesn’t crank up interest rates in positive territory, then the only end game here is inflation and prices going up while people struggle to hold or regain jobs. The government can hand out cash in relief packages all it wants to offset jobless and loss of income, but this just further fuels the fire. If this keeps going, a $1,200 stimulus check from the government won’t buy much or things just won’t be affordable at all.

But cutting stimulus checks gives the pretense of ‘doing something’ for the people on the street. Granted, they’re walking a fine line with the COVID lockdown, but spending into infinity is going to be a losing proposition for all. Giving someone a check is simpler than explaining how velocity of money or banking interest rates work.

Especially in an election year.

The Sky is Falling! Quitting Your Job During a Recession

Coming to a street corner near you!

“Plan for the future, that’s where you’re going to be spending the rest of your life.”

Mark Twain

A recession is coming. Depending on who you listen to, it’ll be here by election day or sometime in 2020. It was also supposed to be here already this year. Or was it 2017? Wait, maybe it was 2015. Remember when they were calling for recession in 2012, just 4 years after the Great Recession? Every year economists or newspapers warn of the ‘coming recession’ that lies just over the horizon.

After seven years of calling it wrong you’d think they’d give it a break. But they won’t — sells too many newspapers.

The point is, recessions do come around every so often. They’re a side effect of the business cycle. Borrowing and lending go too far and there’s a snap back. Economic repercussions usually include decreased spending, higher unemployment, tight credit or banks not lending.

So what to do if you’re looking to Quit Your Job or have already broken free?

The average person might fear recessions. They are, after all, times of great uncertainty. As someone in control of their finances, you should be excited at the opportunity that has presented itself. Prices fall in times of recession. Credit dries up, which leads to people spending less money (either because they don’t have it or would rather save or pay down debt), which leads to less sales and more inventory. The law of Supply and Demand tips the other way: demand drops and supply is more available, which brings down the price. In other words, things get cheaper because no one is buying anything.

The stock market becomes a super market sweep. When credit dries up, loans get called. This includes margin calls, where people and institutions that have borrowed money from brokerages to buy stocks and bonds are required to pay back the brokerage. Imagine you went ‘on margin’ in your E-Trade account, borrowing $10,000 and bought a bunch of Apple stock — the economy just dipped and AAPL stock is falling. E-Trade knows you borrowed money to buy a stock that’s losing value; they call the margin loan and you owe them $10,000 immediately. You have to sell your AAPL stock (likely other shares as well to make up the difference in value lost as AAPL stock fell). It’s not just you — hundreds of thousands of other people are being margin called by their brokerages and forced to sell.

If you’ve got cash, now is the time to buy. Over-leveraged (i.e., “bought with borrowed money”) investors have to dump. The stock market falls. Institutions like pension funds and hedge funds panic at the accelerating drop in prices so they sell stocks and buy bonds (generally regarded as safe havens during economic downturns). Them selling accelerates the stock market drop further. If you’ve got a rainy day fund of cash, you can swoop in and buy stocks cheap. When the recession ends and pensions and hedge funds move back into stocks, the prices go back up because they’re being bought. Something else to remember: a lot of stocks (particularly REITs) still pay dividends during recession. You can bolster your dividend ladder pretty well in a recession, adding to your portfolio of cash-paying stocks. Yes, your own stocks you were holding prior to the recession will likely take a hit, but will also likely keep paying dividends. REIT (Real Estate Investment Trusts) absolutely will.

Speaking of real estate, that also becomes another buying opportunity. The 2008 crash is a great example of this. Historically, real estate has always been regarded as a ‘safe investment,’ meaning value holds even during recession. However, recessions usually result in more inventory available in real estate. People who have unaffordable mortgages, suffer job loss, or end up moving due to economic downturn will either sell off their home or allow the bank to foreclose. Commercial property becomes widely available as sales dry up and force business to close or relocate. The more property that’s available, the lower the price goes. Again, law of supply and demand.

Recently, I read an amazing book called The Great Depression: A Diary (which I’m going to do a Required Reading post on), which is a published diary kept by a lawyer during the Great Depression of the 1930s. Throughout the entries over the years, the author bemoaned the fact that if he only had some cash he could buy up swaths of stocks, land, or businesses as they were going for pennies on the dollar.

Having cash when recession hits can set you up for massive future gains. As the old contrarian maxim goes, “buy when there’s blood in the streets.” It may be a bit melodramatic for this post, but the point is to buy when things look the worst.

So who is really at risk when recession time comes?

Employees, for one, at put at risk. If a company is forced to downsize or cut costs, labor is usually one of the first things to go (as it is usually the greatest expense). If you’re working a job and living paycheck to paycheck, you are the greatest at-risk. Loss of even a single paycheck will disrupt everything. Remember how hard employment spiked over the course of 2008?

Indebted people are another group at risk. Debt servicing becomes difficult if income drops or vanishes altogether. In some cases, banks can call a loan (like a mortgage) in the event of non-payment for a previously specified amount of time. Credit cards and personal loans will pile on interest and service fees for non-payment or late payments. Worse, if your income has dropped or you’re living on savings, huge chunks of your monthly income must redirect to debt, leaving you with less for other things. You might even be forced to sell things you don’t want to sell to satisfy debt payments.

Lastly, your business might be at risk. If you’ve read my blog in the past, you know I’m a fan of MJ DeMarco’s The Millionaire Fastlane and DeMarco’s advice of not starting a business based on what you love. You’re setting yourself up to fail if businesses aren’t founded on need. Businesses based on love — yoga studios or frozen yogurt shops — will be obliterated with the next recession. Thousands of etsy shops will close down. Endless side hustles will dry up. Why? Because as credit freezes and people lose their jobs and/or panic, spending vanishes. Subscriptions and memberships are cancelled. Penny pinching goes into overdrive — and these businesses will wither and die.

If, however, you founded your business based on market need, if you’re providing a valuable or even critical service or product, your business can survive. For some businesses, recession brings a boost. Bars and thrift stores thrive. The movie theater had its golden age during the Great Depression as people went to movies looking for escape and during the economic downturn of the 1970s, the Hollywood blockbuster was born. If your business is essential, it can weather the storm.

Back to the Mark Twain quote above. How can you prepare for the next recession if you’re planning to Quit Your Job?

The first one is easy, because you should have been doing it anyway to Quit Your Job: reduce debt. Pay down credit cards, pay off your car or student loan. Reduce your liability, the number of monthly payments, and the amount you need every month to meet bills.

The next best way to prepare is to have cash. Cash is your sword and your shield. You should have an emergency fund ready to cover several months of normal expenses. This will help bridge the gap and not disrupt your life should income drop or cut off altogether. In addition, having cash allows you to pick up assets at severe discount — buying stocks or property that will eventually regain in price. Just as a fun example, take Patrick Industries (ticker: PATK) company profile:

It manufactures and fabricates decorative vinyl and paper laminated panels; fabricated aluminum products; wrapped vinyl, paper, and hardwood profile moldings; solid surface, granite, and quartz countertops; cabinet doors and components; hardwood furniture; fiberglass bath and shower surrounds and fixtures; softwoods lumber; simulated wood and stone products; and others.

After the housing crash in 2008, the stock cratered to 28 cents per share. It’s obvious to see why, given its significance to home renovation and construction. From the low in March 2009 to the end of 2017, PATK gained over 24,000% in stock value. This is an extreme example, sure, but it illustrates how buying up something so unwanted could great gains in the future.

There’s a reason they say “cash is king,” and it has its roots in the Great Depression. At a time when everyone is selling assets to get cash, having cash makes your royalty.

If you want to learn more about setting yourself up to thrive in the next recession, check out some books like Recession-Proof by Jason Schenker or Recession-Proof Living by Bill Weise.