What is a Recession?
There are many words out there that describes both the economy and the markets. Words like correction, bear market, bull market, stagnation and inflation. But a recession is different. Technically, a recession is where we have 2 quarters in a row of negative growth as measured by the GDP or Gross Domestic Product.
GDP measures all the goods and services produced in this country. It is based on 4 areas;
Consumption -- the money you and I are spending on things like coffee, cars or other everyday items as well as services like a haircut.
Investment – this measures how much business’s spend on things like buildings, equipment or expansion.
Government – Government spending would be things like defense, schools and roads.
Net exports – How much a country is exporting vs importing.
So when growth in these areas turn negative for 2 quarters in a row, then we are technically in a recession.
What are warning signs of a recession?
According to businessinsider.com an inverted yield curve between the 2 year treasury bond and the 10 year treasury bond is among the most consistent indicators. It’s a sign that investors are nervous about the short term and are will flock to long term bonds which pushes the yield lower. Also when manufacturing companies get fewer orders then they may have to lay off workers. These signs are typically viewed as a warning that a recession may be on the way.
What Causes a recession?
When the economy is healthy companies are hiring more employees and consumers are spending more on products and services. But if businesses and consumers stop spending then the money flow slows down. Several factors may cause this to happen. One is high interest rates. When interest rates are high then people get more interest when they save. But on the flip side loan rates will go up as well causing people to think twice about borrowing on concentrate more on saving instead of spending. Consumer confidence is another area to look at. When consumers are worried about the economy it can cause them to hold on to their money. Inflation may be the biggest factor. If the costs of goods and services increase and your paycheck isn’t growing at the same rate, it may cause you to cut back on your spending. Other causes can be caused by an exogenous shock like the surging gas prices in 1979 or like the COVID-19 pandemic. These exogenous shocks are somewhat unforeseeable and can be harder to manage.
How long do recessions last?
According to NBER data recessions last on average about 11 months. But has been as short as 6 months in 1980 and as long as 18 months during the great recession from 2007 to 2009. While it’s no fun to go through a recession take note that markets have historically recovered to new highs. This is why it may be a good idea to reassess your risk tolerance to make sure it is in align with your goals and objectives.
Keith Wilson, CLTC
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All performance referenced is historical and is no guarantee of future results.