If you’ve listened to the news the past two years, you may have heard speculation on when the next recession will be. Commentators are looking for signs as to when the recession will start and making predictions for how it will impact the markets. Since recessions are notoriously hard to forecast, that means a lot of people are giving their opinions. This can lead to confusion, and maybe concern, in listeners and readers who are just trying to understand what is happening in the economy.
What is a recession and why are they hard to predict?
The historical definition of a recession is a decline in general economic activity, often measured by two consecutive quarters of decline in Gross Domestic Product (GDP). The GDP in the United States is calculated by the Bureau of Economic Analysis (BEA) and is defined as the value of the goods and services produced in the United States. Since this number is a measure of U.S. economic activity, it is a closely watched indicator of economic health.
While the BEA measures GDP, in the U.S. a recession is declared by the National Bureau of Economic Research (NBER). The NBER, however, does not look for two consecutive quarters of declining GDP, but defines a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
Each of the recession components above, plus additional market factors, can be evaluated as “indicators” of a recession. The problem is that they are not consistent. They can occur without being tied to a recession, do not all happen simultaneously during a recession, and the timing of when an indicator appears at the trough (bottom) of a recession can vary each cycle. That’s why people are looking to see if multiple indicators occur together, for more evidence to point to a recession occurring in the near future.
You may be beginning to understand the difficulty of predicting a recession. To make it even more complicated, the measurements of economic factors are compiled by both governmental and private organizations. Calculations can be made monthly, quarterly or annually depending on what’s being measured and the available data. To complicate it further, those groups often revise their initial estimates as more data becomes available.
Why is everyone expecting a recession?
Recessions are a normal part of the economic cycle. Since the first recorded recession in 1854, there have been 33 recessions in the United States. On average, in this time frame, we have had a recession around every 56 months with each recession lasting about 17.5 months. Since World War II, the average recession has been shorter, at close to 11 months, and the average cycle has gotten longer to nearly 69 months. This means a longer period of expansion between recessions, on average about 58 months.
The last recession in the U.S. ended in June 2009 meaning this expansion period is over ten years old. The longest previous expansion period lasted 120 months from March of 1991 to March of 2001. The longer the expansion period lasts, the more people will begin to look for signs that it is ending.
What causes a recession and how does it impact society?
It depends on which economist you ask. There have been many factors that have caused recessions over the years from government policy, social factors, market pressures, and more. With hindsight being 20/20, it is always easier to tell what happened to cause a recession than predict what factors today could cause a recession, which adds to speculation. One factor that is watched in every recession is unemployment. As GDP falls, less goods and services are being produced, and there tend to be layoffs.
Is the next recession going to be as bad as the last?
It’s important to remember each recession is different in cause, length, and severity. There can be a recency bias when considering how a recession can impact you. The most recent recession, known as the Great Recession, was the greatest decline in GDP post-World War II at 4.3%. It lasted 7 months longer than the post-war average at 18 months and unemployment nearly doubled from 5% to 9.5% over that time. Unemployment peaked at 10% a few months after the recession ended in October of 2010.
If you compare that to the previous recession that occurred in 2001, GDP fell .3%, the unemployment rate reached 5.5% during the recession, and it only lasted eight months. The recession in 2001 was caused by the market drop following the dot-com bust in 2000 and was exacerbated by the 9/11 attacks. It did not impact global financial institutions to the depth and pervasiveness as the Great Recession did. Since we can’t predict what the next cause of a recession will be, it’s hard to say exactly what it will look like. But statistically, the severity of the Great Recession was an outlier.
How do recessions impact the market?
Stock prices are typically tied to the profitability of a company and optimism in the economy continuing to grow. As the economy slows, a company’s profits can decline as people spend less. This can lead to a drop in the overall market; but historically, it’s not a drop that lasts forever. Below is a chart of the S&P from 1990 through today, with recessions marked in gray.
As markets fall, it creates a buying opportunity for those who are willing to invest when the market is “on sale.” At Cassady Schiller Wealth Management, our rebalancing naturally allows for buying low and selling high to take advantage of these opportunities. Working with an advisor can also help you to not react emotionally to the stress of the economy and volatile markets by creating a plan that you can stick to. While recessions can be painful, they don’t need to be faced alone. Please reach out to your Cassady Schiller Wealth Management advisor if you ever have any questions or concerns about how economic factors can impact you.