Let’s talk recessions. The dreaded word is making its way back into the mainstream as financial markets trade in a bear market, and the Federal Reserve Bank of Atlanta’s GDPNow model predicts a slight decline in economic activity for the second quarter. If this pans out, it will mark two consecutive quarters of negative GDP growth, which many believe would indicate a recession in the U.S. However, this is a misconception. The National Bureau of Economic Research (NBER), who is ultimately responsible for calling recessions, defines such an event 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.” The two quarters of negative GDP growth meet the recession criteria of “lasting more than a few months,” but it leaves out many important areas of the U.S. economy.
Employment is arguably the most critical data point; it is hard to have a recession when people are working. The U.S. economy added over 2.7 million jobs during the first half of 2022, averaging 457,000 per month. Currently, almost two jobs are available for each person looking for work, and the unemployment rate has been sitting at 3.6% since March. Some economists point out that the jobs report is a lagging indicator. Instead, we can use weekly initial jobless claims as a more real-time proxy, and these tell a similar story. While there has been a slight uptick over the past few months, overall claims remain at low levels relative to history, indicating the labor market remains strong.
While employment remains strong, the same does not go for all variables the NBER uses to determine a recession. It is hard to say any data points are truly warning of a recession; however, some indicators appear to be peaking, and it will take longer to forecast a trend. For instance, real incomes are lower due to elevated inflation. Industrial production remains strong but may have peaked for this cycle. Consumers continue to spend, but credit card usage has increased, meaning retail sales may weaken in the future when those credit card payments come due, especially if inflation continues at high levels. Although not all indicators are as strong as a few months ago, they are not necessarily signaling recession territory, though caution is warranted.
The truth is, no one knows when the next recession will occur, its severity, or the duration. The only thing we know with certainty is that there will be one; on average recessions occur about every seven years.
Before 2020, we went over a decade without a recession, and other than the pandemic-induced recession, most people tend to compare the current environment to 2008. During that time, financial markets collapsed due to banks’ lax lending standards, which allowed anyone to get a mortgage. At that time, mortgages were also combined into complex financial instruments, and bankers did not consider the possibility of homeowners being unable to pay their debts.
Fast forward to today, and concerns have been raised that we are in a similar situation due to the hot housing market. Today, banks are held to higher standards and forced to maintain capital levels to provide liquidity to markets in times of stress. In turn, banks now hold borrowers to higher standards to ensure they can repay their debts in full. In other words, when a recession does occur, remember, it is not 2008. Consumers are better positioned to handle a downturn than they were 15 years ago. Many households still have savings from the pandemic, (although this has decreased due to inflation), and household debt is sitting at a 50-year low. Financial institutions are not holding all the subprime debt that inflamed 2008 and are well prepared for a low liquidity environment. While no one wants to see a recession, they are a normal part of economic cycles.
Although we cannot say what the next recession will be like, we are confident investors will emerge with their long-term goals intact. Some households will make changes, like decreasing their discretionary spending. However, making significant portfolio changes is ill-advised. Portfolios are built to participate in up markets while protecting in down markets relative to each investor’s risk tolerance. While it may be a difficult to watch, this too shall pass, and the economy and markets will continue the long-term growth trend, moving investors toward their long-term goals.
Author: Joe Clark, CFA | Research Team | Allegheny Financial Group | July 2022
The information included herein was obtained from sources which we believe reliable. This report is being provided for informational purposes only. It does not represent any specific investment and is not intended to be an offer of sale of any kind. Past performance is not a guarantee of future results.
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