A Recession by Any Other Name

Friday Reflection | August 5, 2022

“What’s in a name? That which we call a rose / By any other name would smell as sweet”

– Romeo & Juliet, Act II, Scene II

Headlines have debated the timing and probability of a recession all year as economic activity has slowed down. There are plenty of culprits to point to – Russia’s invasion of Ukraine, persistent high inflation, the Fed’s interest rate trajectory, geopolitical uncertainties in Taiwan. Given the fact that equity prices entered a bear market in the first half of the year (despite modest recovery in recent weeks), it may seem surprising that we aren’t officially in a recession yet.
 
Confusion is created by the fact that a “recession” doesn’t have a simple quantifiable definition. This absence of clarity caused Wikipedia to shut down its page on recessions this week due to ‘edit warring’ and a lack of consensus about the actual definition.¹ When we move beyond theory, we encounter the messy complexities of the real economy. Inflation is rising, yet employers are still hiring and keeping the labor market strong.² Corporate profits in certain sectors have plummeted, but other industries ranging from energy producers to tourism and ride-sharing companies have reported record earnings in recent weeks. Amidst these mixed headlines, it can be helpful to remember that periods of economic slowdown – whether they are officially deemed a recession or not – are a normal part of the economic cycle.

Recession is a word that evokes images of financial stress and catastrophe. It might conjure memories of 2008 or prior downturns caused by asset bubbles, inflation, or economic shocks such as the pandemic. That imagery softens a bit when we keep in mind that recessions are a normal and recurring part of the business cycle. There have been 33 official recessions in the United States since 1857.³ Despite these regular pullbacks, both the economy and financial markets have grown significantly in productivity and value over that period.

An oversimplified definition of a recession was coined in 1974 by US economist Julius Shiskin when he described it as “two consecutive quarters of declining growth.” In Q1 of this year, the US GDP contracted at a pace of -1.6%. In Q2, our economic output further shrank at a pace of -0.9%. This meets the unofficial definition of a recession, hence the current confusion.

The formal definition of a recession is “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough.” This qualitative language leaves a lot of room for interpretation and confusion. The National Bureau of Economic Research (NBER) is the institution charged with determining the official start and end dates of any recession. The NBER focuses on a comprehensive set of measures – including not only GDP but also employment, income, sales, and industrial production – to analyze the trends in economic activity. The nature of this analysis and examination of past data means that recessions are only formally recognized in hindsight.

Financial markets don’t care whether the NBER has made an official announcement. In the modern world, investors have access to troves of economic data on an almost real-time basis. Downward economic trends are incorporated into prices long before the economists at the NBER announce the country has been in a recession. Market pricing represents investor expectations of corporate earnings in the future. If a recession is expected to be short-lived, as was the case during the pandemic downturn, prices might even establish a new upward trend prior to the NBER’s official announcement. In other historical examples, recessions persist for longer periods of time. In all cases, the market adjusts stock prices downward long before the official recession moniker is bestowed on the economy.
 
In the current market, investors are trying to gauge whether a potential recession will impact the Fed’s plan for markedly higher interest rates. If the economy dips into recession, the Fed may be pressured to curtail their planned interest rate hikes sooner than previously forecast – which would provide a tailwind to bonds and growth stocks alike. If the Fed or other central banks were to change course and lower short-term interest rates, the investor reaction would be even more positive.
 
While the economic landscape shows plenty of signs of slowing, there are also signs of strength that dispel any notion that we’re currently in a recession. The US economy added 528,000 jobs in the past month, moving the unemployment rate to a 50-year low at only 3.5%.⁴ This is positive for job-seekers but also stokes fears amongst investors that the Fed could push rates even higher in the short-term. For investors, it means that volatility is likely to persist and regular rebalancing remains the optimal approach.

Just as tragedy befell the titular characters in Shakespeare’s play, the negative consequences of a recession are quite real (though generally less deadly). Companies face economic headwinds during a recession, which can lead to layoffs or decreased compensation, which in turn dramatically affects personal trajectories and planning. Even for those who are not directly impacted, financial stress can lead us to alter our spending patterns or delay planned trips or projects.
 
For investors, history has shown that significant opportunities tend to present themselves during a recession. Stock prices usually overcorrect to the downside, and investors can buy shares of high-quality businesses and diversified indexes that offer attractive upside over the long-term. Personal planning and investment decisions made during these periods of market stress commonly serve as the foundation for strong growth over more generous periods of the market cycle.

“Wisely and slow. They stumble that run fast.”
Romeo and Juliet, Act II, Scene III

Resources

¹ What is a recession? Wikipedia can’t decide NPR

² These 8 measures reflect a slowing U.S. economy. NY Times

³ US Business Cycle Expansions and Contractions NBER

⁴ US Job Growth Surges, Tempering Recession Worry and Pressing Fed Bloomberg