Recession Origins & Opportunities

Until the Great Depression, the word “recession” did not exist. Any time the economy contracted the prior 150 years, it was considered a depression. This did not exactly create a positive psychology. It also did not help that each depression until then had lasted several years. Prior to the 1930s, policy makers did not have the tools or understand how to steer the economy out of a downturn.

In an effort to change the narrative, policy makers introduced the word “recession.”

Recessions are simply a part of the cycle in our economic system. There are four stages of the cycle: expansion, peak, contraction, and trough. Then the cycle begins anew.

While a recession is technically two negative quarters of GDP, it needs to be a significant decline in economic activity across markets.

Following the negative growth of GDP in the first quarter of this year, the possibility of recession is on many people’s minds. The latest consumer surveys by the University of Michigan have fallen sharply, driven by high inflation. Housing starts and retail sales are beginning to slow.

Many other data points suggest a recession is not imminent. The State Coincident Index by the Philadelphia Federal Reserve looks at employment data across each of the 50 states. As an indicator of impending recession, signs of employment contraction are first seen in a handful of states, and then becomes evident in the majority. As the chart below shows, all 50 states as of April show employment growth.

The concern for investors is the temporary decline in stock market prices during recessions. Assuming the investor has no immediate cash flow needs or leverage on the portfolio, then the concern should dissipate.

Once the economy is in a recession, it is typically old news to the stock market. In fact, markets typically bottom several months or quarters prior to a recession being officially called by the National Bureau of Economic Research. The chart below shows recessions marked in grey vertical bars. In 7 of the 8 recessions, stock prices bottomed well before the next expansion began.

This goes to the old adage, “Buy at the sound of cannons and sell at the sound of trumpets.” To those with diversified portfolios, this means buying or selling around your asset allocation targets – it does not mean going all-in or all-out.

In Thinking Fast & Slow, Nobel Prize winner Daniel Kahneman describes our brains as having two systems. System 1 reacts quickly and is useful in many scenarios. This would be investors thinking recession = time to sell stocks. System 2, on the other hand, thinks slowly, analyzing and deducing information. This would be investors thinking recession = time to buy stocks.

Of course, every cycle is unique. The current cycle certainly is on fast forward as compared to the expansion from 2009 to 2020. Unemployment is below 4%, the Federal Reserve is raising interest rates, and the stock market packed in a decade of gains in just two years. The data may be at the early stages of trending negative, but the calls for a sustained decline in economic activity may be premature.

We will invariably have a recession again. The question is whether financial plans and a durable investment process is in place to navigate to the next cycle.

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