How Do We Know If We Are In A Recession? And What To Do About it.

Recessions

While we use the term recession to describe various periods of economic contraction, recessions come in all shapes and sizes and differ in both duration and composition. Below are some questions, examples, and information to help you understand the meaning and impact of a recession on our economy and financial investments.

 Who decides when we are in a recession?

The National Bureau of Economic Research (NBER) is the authority that declares a recession in the United States, though its Business Cycle Dating Committee does so after analyzing various economic indicators, often with a significant time lag. The committee determines the start and end dates of recessions, which are defined as a "significant decline in economic activity that is spread across the economy and lasts more than a few months".  

Does the General Rule of Thumb of “Two Consecutive Quarters of Negative GDP” still hold?

Not really. Two consecutive quarters of negative GDP may indicate an economic slowdown, but since the data could be as old as 6 months (from the start of the first negative quarter), the economy may not be in the same condition when the report is released.
For example, assume the first-quarter GDP is negative - 0.02%, and the second-quarter GDP is negative - 0.01%.  The second-quarter GDP is an improvement over the first quarter, though it remains negative and falls within the traditional definition of a recession.  

How do we know when we are in a recession?

That’s a good question, because the methods used to formally declare a recession are based on variables that can be several weeks old and given different weights from quarter to quarter. The data used to indicate a recession are backward-looking. Conditions in the market may have changed during the “lag” period.

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Another problem is that recessions are not the same. There are no specific answers to the questions of “How long does a recession last?” or “How many jobs will be lost? Will the Fed increase the money supply to bolster spending by lowering interest rates or reducing bank reserves? Will stock prices fall, and by how much?

Consider the Global Financial Crisis as an example: That recession started in December 2007 but wasn’t announced until a year later in December 2008. By then, stocks around the world had already dropped more than 40%, factoring in the expected impact of a slowdown. Although the recession ended in May 2009, the official announcement of the end of the recession came more than a year later, in September 2010, and well after stocks had begun to rally.

Of course, investors would like a reliable signal to tell them when to be in or out of the market. But current market conditions don’t reveal the beginning or end of a recession—and even economic experts may offer divergent forecasts on the timing and severity of a recession.

Investors may be tempted to abandon stocks and move to cash amid concerns about the potential impact of a recession. But from a market perspective, prices have likely already factored in the possibility of a recession, and stocks have already declined.

Reducing exposure to stocks due to concerns about a recession may lead to missing out on returns during a market recovery. Consider that over the past century in the US, stocks have usually delivered positive returns within 24 months of the start of a recession, with an average annualized return above 8% over that period.2

Recessions understandably trigger worries over how markets might perform. But history can be a comfort for investors considering a move out of stocks. We have data from many recessions worldwide and see that markets have not only recovered from past recessions but, in many cases, have ultimately recovered strongly.

It’s essential to stick to your portfolio allocation over the intermediate- to long-term, which should already account for economic variability. Your real target should be achieving your long-term goals, not trying to predict a short-term economic blip.

For more information about our services, please view our website. You can also contact us by phone at (925) 484-1671 or by email with any questions or to schedule a complimentary consultation.

Anthony B. Carr, CPA, CFP®, MBA

Past performance is no guarantee of future results. Investing risks include loss of principal and fluctuating value. There is no guarantee an investment strategy will be successful.