Recession Doesn’t Equal Crisis

Economists and prognosticators are increasingly predicting that the U.S. economy might be headed for recession. However, the specific circumstances of the current economy are rather different from the circumstances that led to the crisis that came with the 2008 recession. Previous recessions suggest that not all recessions have to be so long and difficult to get over.

It may not be unreasonable that economists are worried about a recession. Last month, a key predictor of recession flashed a warning signal. Interest rates on long-term debt fell below interest rates on shorter-term debt. This almost never happens – investors typically demand a higher interest rate when they lock up investments for longer periods of time. 

This phenomenon, known as an inverted yield curve, has preceded each of the last seven recessions. Even though the daily change in interest rates was trivial – interest rates had been trending in this direction for some time – investors got spooked and triggered a sell-off in U.S. stocks the day after the yield curve inverted.

Investors should always keep in mind two important things when thinking about the economy: One, the stock market is not the economy. This means that just because the economy falters does not mean the stock market will act in the same way. Two, even if the stock market perfectly reflected the economy, it would be impossible to predict the timing, duration, or magnitude of a recession.

A recession simply means that the economy has stopped growing. The official definition of recession is that gross domestic product (GDP) decreases for two consecutive quarters. 

Our last recession in the United States, the financial crisis in 2008, was particularly bad. It was also preceded by a number of unique conditions. Among other things, the banking system had created new financial products that encouraged underqualified applicants to take out excessive mortgages. The impact of the recession was broad and deep. Jobless rates spiked and the subsequent recovery was slow. That same set of circumstances, the perfect storm for a severe recession, does not exist today.

During the last recession, the U.S. stock market fell by 35 percent from the official start to the official end date. 

However, a look back at history suggests that not every recession has to be so bad. 

There have been 15 U.S. recessions in the last 95 years. Eleven of the 15 official recessions lasted one year or less. The duration of our previous recession, in 2001, was seven months, during which the U.S. stock market declined just 1 percent. 

Perhaps more importantly for investors, of the 15 official recessions, eight of them saw positive returns in the U.S stock market. A “cyclical” recession in the midst of a longer-term “secular” growing economy and bull market could end up being nothing more than a blip on the radar over the long-term, such as the case with two short recessions at the beginning of the 1980’s and another in 1990.

The current set of economic circumstances may not be ideal – the trade war has been pointlessly damaging for US producers and exporters –  but they are far from what we saw in the lead-up to 2008. Market timers who hope to jump out just before recession and jump back in just after may end up getting whipsawed. They’ll likely end up getting out too early or too late, and then they also have to guess when to get back in. 

A recession may have a serious impact on certain jobs, such as those that work in construction or seasonal work. But investors needn’t get too caught up in trying to predict when the recession might come or how it might affect their portfolio value, so long as they can maintain a little historical perspective. Most importantly, the specific conditions that predicated the 2008 financial crisis are not in place this time around. 

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