The financial industry has historically defined a recession as two consecutive quarters of negative growth of the Gross Domestic Product (GDP). However, the National Bureau of Economic Research says this rule may not always hold true. They are quick to remind us that the recession of 2020 saw just one quarter of negative growth. But let’s face it, COVID-19 caused us to redefine a lot of things!
GDP is the market value of all finished goods and services produced within a country. Basically, it tells you how the country’s economy is performing.
How Do We Know When a Recession is Coming?
Recessions will be hard to avoid for many countries around the world as economic growth is hampered by the war in Ukraine, pandemic lockdowns in China, and international supply chain disruptions. There are many indicators that may signal an impending recession – unemployment, consumer confidence, household debt, inflation, interest rates and an inverted yield curve. The yield curve is a graphic representation of the relationship between the interest yield of U.S. government debt instruments of varying maturity dates. An inverted yield curve means that short-term government debt has a higher yield than long-term government debt, and historically a recession happens ten to twenty-two months after an inverted yield curve; but not always. We have seen a briefly inverted yield curve in the past 12 months, and some see this as a warning sign.
Consumer spending is responsible for almost 70% of the GDP. So, the question is “are you spending more in the current quarter than you did from January to March?” Current estimates are that consumer spending has slowed since the government stimulus payments we received have been mostly spent. Another concern is whether inflation will cause consumers to spend less because things cost more. The Federal Reserve has signaled that they plan to continue to raise interest rates to slow inflation, and many investors fear that these efforts will lead to increased unemployment. If the central bank raises rates too far and too fast, economists worry, it could tip the economy into recession. Eight of the past eleven extended rate-hike cycles have eventually ended in recessions.
How Has the GDP Done So Far This Year?
There was a 1.4% drop in GDP for the quarter ending March 31st. GDP indicators for the second quarter show an economy teetering on the edge of negative GDP growth. The most recent estimate for growth in the second quarter is 0.9% to 1.3%, so if the final numbers come in slightly lower than the estimate, we could be in recession territory. We won’t know for sure until the numbers are released in July. Even if the quarter comes in with positive GDP growth, we are still not out of the woods.
The Great Recession that began in December 2007 saw the steepest decline in the market since the Great Depression in 1929. The S&P 500 dropped 57%, but within one year after hitting bottom, it had jumped back up 68%. The average length of a recession since 1945 has been 11 months. That brings us to the next question.
What Should You Do to Prepare?
This is a simple answer – nothing. Recessions are a normal part of the business cycle. There are periods of economic growth and periods of economic slowdown. They are parts of the same cycle. The 2020 recession was unprecedented because it occurred when Covid upended the economy by forcing businesses to shutter and encouraging people to stay home. If your personal circumstances or long-term goals have significantly changed, regardless of whether we are in a recession or not, schedule an appointment with your trusted financial advisor.
Robert M. Eckenroth | CPA, MBA