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Are We In A Recession?

Does it really matter?

There has been a lot of discussion in the financial press trying to gauge whether we are in a recession. There is no argument the pace of economic activity has declined. According to the Bureau of Economic Analysis (BEA), gross domestic product (GDP) contracted for the first two quarters of 2022. Two quarters of negative GDP growth has been the widely accepted definition of a recession. It is kind of like Memorial Day is the beginning of summer. It may feel like it and everyone acts like it, but it is not the true definition. Unlike summer (which does have a precise start and end), recessions are not always so exact.

U.S. Bureau of Economic Analysis chart of Real GDP: Percent change from preceding quarter

Source: copied from BEA website

The National Bureau of Economics Research’s Business Cycle Dating Committee is tasked with determining the start and end of recessionary periods. The NBER’s criteria “emphasizes that a recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months. In our interpretation of this definition, we treat the three criteria – depth, diffusion, and duration – as somewhat interchangeable.” This means they look at the severity (depth) of an economic slowdown, how widespread it is across the whole economy (diffusion) and not something affecting only specific industries, and how long the downturn lasts (duration). They are not equal weighted, however. If one of the three Ds is extreme, it could offset one area that is not as bad. The NBER uses the pandemic-induced recession is an example. It was very severe and widespread, but short.

Another aspect of the NBER’s Business Cycle Dating Committee is they intentionally wait until there is sufficient evidence of turning points to make an official determination of the peaks and troughs of economic activity. They do this so there is no need to make major revisions. This is why there is always going to be speculation in real time as to if we are or are not currently in a recession.

Source: NBER

Two quarters of negative GDP growth, high inflation, rising interest rates, and home sales normalizing fuel recessionary beliefs. On the other hand, unemployment is low at 3.5%, consumers are still spending based on the latest data, and the stock market has been trending higher since mid-June (but still negative year-to-date).

The labor component may be the positive aspect for now. Jonathan Golub, of Credit Suisse, wrote in a recent research report* that “the most important set of indicators in determining a recession, current labor conditions, appear inconsistent with an economic contraction." He adds, “The NBER considers a variety of factors in determining a recession; however, the data indicates that a sharp deterioration in the labor market is the only consistent gauge." Based on this belief, a strong labor market positively offsets the negative economic trends. If, and how long this persists, we do not know.

We cannot predict whether the current environment will be deemed a recession in hindsight. Hopefully, inflation can subside without significant adverse impacts to the economy. Whatever the final decision is, savers and investors should not wait for a committee to tell them how their situation is. A financial plan should have built-in expectations of recessions and below average market returns. It does not mean we should welcome those times, but it should make it more manageable. Market and economic cycles are inevitable. It is still smart to speak with an advisor about how your portfolio and plans are holding up.

If we are currently in or soon-to-be in a recession, it will affect everyone differently. Losing a job is devastating, especially without an emergency reserve and/or income from a spouse. For those fortunate to remain employed, it might be prudent to scale back on discretionary purchases and build up savings. When times are good, we need to prepare for when they are not. With the equity and bond markets both declining coupled with higher inflation, the economic pain is already being felt. Whether a committee labels it a recession or not will not change that.

* Jonathan Golub, Credit Suisse Equity Research, "CS Guide to Recessions", 17 August 2022



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