Just in Case

Jonathan Clements

A YEAR AGO, I WAS worried about the stock market. Today, I’m concerned about the job market.

In December 2017, I penned an article entitled Best Investment 2018, which turned out to be surprisingly prescient. That wasn’t really my goal. At the time, I was simply pondering rich stock market valuations, tiny bond yields and the new tax law, with its higher standard deduction and limits on itemized deductions. Putting it all together, it struck me that paying down debt—even mortgage debt—seemed like an awfully smart move.

Since then, the S&P 500 has dipped modestly, while reported earnings per share are expected to climb 28% in 2018. The passage of time has done the work usually done by market declines: It’s helped to sharply improve stock market valuations.

A year ago, the S&P 500 companies were trading at 25 times their reported corporate profits for the prior 12 months. Today, that multiple is down to 19.9, based on earnings for the 12 months through 2018’s third quarter from S&P Global. A year from now, the S&P 500’s price-earnings ratio could be as low as 17, assuming stocks continue to tread water and earnings come through as expected.

To be sure, stocks remain expensive by historical standards. But that isn’t especially alarming. After all, stocks have been overvalued for much of the past three decades, plus today’s lowly bond yields are hardly a compelling alternative.

And to be sure, 2018’s handsome earnings growth has been fueled by 2017’s corporate tax cut and by continued fat company profit margins. The onetime boost from cutting taxes won’t, of course, be repeated in 2019. But there doesn’t appear to be any immediate risk that the tax cuts will be reversed.

Does that mean the recent market turmoil has run its course? I have no clue. Forecasting short-term market performance is a mug’s game, because it necessitates predicting not just the news, but also how investors will react to that news.

Indeed, when it comes to stocks, I find myself firmly on the fence. On the one hand, we haven’t seen anything that looks like a market bottom. There’s been no revealing of financial excesses, no squeals of economic pain, no horrendous decline in stock prices, no relentless declarations of doom from the pundits. On the other hand, thanks to improved valuations, buying stocks today doesn’t seem nearly as perilous as it did a year ago.

That brings me to the question everybody seems to be asking: Will the economy weaken? The financial markets appear to think so. The stock and bond markets are suggesting that a recession could be in the offing. When I look around, I don’t see many signs of a U.S. economic slowdown. But it’s foolish to argue with the markets, which reflect the collective wisdom of all investors.

If the economy does indeed weaken, the big worry for many families won’t be the stock market. After all, only half of Americans even own stocks and stock funds. Instead, the top concern for most Americans will be the job market.

We’re now at 3.7% unemployment, down from 10% in October 2009. The Federal Reserve expects 2.5% real economic growth in 2019, with unemployment dropping even further, to 3.5%. Let’s hope the Fed is right.

But in case the folks there have it all wrong, there’s good news: You might have 12 months or more to prep your finances for rough times. How come? The stock market is a leading indicator: It starts falling before the economy contracts and it rallies before a recession is over. By contrast, unemployment is a lagging indicator: Companies are slow to shed workers when the economy turns sluggish, though they’re also slow to rehire when economic growth resumes.

Worried you could lose your job in the next economic downturn? The obvious move is to stockpile cash. While that’s prudent, it shouldn’t necessarily be your top priority. Here are seven other things to do now:

  • Get rid of credit card debt. No matter what happens to the economy, that’s a smart move. What if you later need cash because you got laid off? While not advisable, you can always “reborrow” from your credit cards.
  • Pay off 401(k) loans. If you lose your job, any 401(k) loans must be repaid right away. Don’t have the necessary cash? The unpaid loan becomes a taxable distribution, triggering income taxes and tax penalties.
  • Keep funding the 401(k), especially if it comes with a matching employer contribution that vests immediately. Even if a bout of unemployment forces you to dip into your retirement account, you’ll likely come out ahead, because the matching contribution you collect could be worth more than any tax penalty you pay. On top of that, you may be able to delay any retirement account withdrawals until the next tax year, when your lack of income puts you in a lower tax bracket.
  • Fund a Roth rather than a tax-deductible IRA. If you need cash, you can withdraw the dollars you contributed to your Roth with no taxes or penalties owed. Taxes only become an issue if you touch the account’s investment earnings.
  • Set up a home-equity line of credit. This could provide another source of cash, should you find yourself out of work. One warning: If we get a deep recession, some banks may respond by cutting the size of credit lines, including those already established.
  • Calculate your fixed living costs, so you know the minimum sum you need to make it through each month. While you’re at it, ponder whether there’s any way to cut those fixed costs. If you don’t have a paycheck coming in, you want to do everything possible to limit the dollars going out.
  • Think hard before taking on new financial obligations. For instance, you might keep your current car for a few more years. If your job is at risk, this probably isn’t the best time to take on a car loan or use your spare cash to buy a new vehicle. What if you still have money owed on the last car you purchased? If the interest rate is, say, 4% or above, you might make extra payments to get the loan paid off sooner.

Follow Jonathan on Twitter @ClementsMoney and on Facebook. His most recent articles include No KiddingTaking Us for FoolsThe View From Here and A Little Perspective. Jonathan’s latest book: From Here to Financial Happiness.

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