Looming Recession?

May 12, 2022

Downward markets have been drawing a lot of attention as of late.  Among the many potential reasons for a decline is a slowing economy.  Market pundits have been busy vocalizing their predictions on whether a recession is on the horizon and, if so when it might occur. Recessions have been loosely defined as two consecutive quarters of negative gross domestic product (GDP) growth. However, the organization that officially declares recessions, The National Bureau of Economic Research, uses broader criteria. They define a recession as a significant decline in widespread economic activity, lasting more than a few months. Their determination is based on factors that not only include GDP growth but additionally employment, industrial production, retail sales, and real income.

To see where we are now, let’s look at these metrics:

Employment

The U.S. is currently experiencing one of the strongest job markets on record, with 11.5 million job openings and unemployment of 3.6%. For every unemployed worker, there are 1.9 job openings. Yet, companies are having difficulty finding and keeping workers, putting upward pressure on wages.

Industrial Production

In April, the manufacturing and service sectors continued their broad-based expansion, albeit both at a slower pace. Companies reported strong demand from consumers, yet with headwinds consisting of a shortage of labor, inflation, and supply chain problems that have been exacerbated by COVID-19 shutdowns in China. Positively, as shown in the chart below, the commonly used forward-looking measurements both stand above 50, representing economic expansion rather than recession.

Retail sales

March saw 6.6% year-over-year growth in retail sales, above the average retail sales growth of 4.8%. Sales growth is important to overall economic growth, as consumer spending contributes 69% to the U.S. GDP.

Real personal income

Personal income, which includes wages and government assistance, rose 0.5% in March, month over month. However, when we consider inflation, the average individual saw their real income drop 0.4%.

GDP

Real (after inflation) GDP contracted at an annualized rate of 1.4% in the first quarter of 2022. Main contributors to the decline in growth were strong consumer demand for imports, slower inventory stocking by companies, and a widening trade deficit.

Recession or Not?

In summary, the strong labor market and healthy level of retail sales, as well as the continued growth in the manufacturing and service sectors, are not pointing to a recession at this time. On the other hand, declines in growth for both real income and GDP could be signaling a recession that could come on the horizon.

On top of that, inflation of 8.3% (year-over-year through April) is also driving some of the recession concerns if the Fed can’t get it under control. The Federal Reserve has begun to raise the Federal Funds rate from near 0% in an attempt to tame inflation. The Fed increased rates by 0.25% in March and announced another 0.5% increase last week. Market forces are currently forecasting a 3.25% rate by the end of next year. Only time will tell whether raising rates, as well as reducing the amount of bonds on the Federal Reserve’s balance sheet, will work to reduce inflation to a sustainable level without causing a recession. In the meantime, this unknown contributes to risk, making the market volatile.

No doubt, fear is high right now, especially with the stock market turbulence. However, even if we do head to a recession, markets continuing to be negative are not the norm.  In fact, if you look below at the performance of both stocks and bonds in recessions, they are counterintuitively positive.  This doesn’t mean the ride will be smooth, but having a recession has more commonly been a buy signal than a sell signal.

RecessionsU.S. Stock PerformanceU.S. Bond Performance
3/1/45-10/31/4519.5%1.0%
12/1/48-10/31/4915.2%2.5%
8/1/53-5/31/5424.2%5.1%
9/1/57-4/30/58-1.5%9.7%
5/1/60-2/28/6120.3%7.2%
1/1/70-11/30/70-2.0%16.2%
12/1/73-3/31/75-5.9%5.7%
2/1/80-7/31/809.6%9.5%
8/1/81-11/30/8210.5%29.1%
8/1/90-3/31/918.0%7.5%
4/1/01-11/30/01-0.9%5.9%
1/1/08-6/30/09-25.0%4.8%
Average6.0%8.7%

Source: Blackrock

While we don’t know if or when a recession will occur, we do know that recessions are a normal part of the business cycle and are typically short-lived. Of the 12 recessions since 1945, the average recession lasted just ten months. It is important to focus on market gains over the years, not solely on months of losses. Over the long term, investors can count on the strength of the US economy, knowing their portfolios will be rewarded.

Disclosures:

In table above, stock market return represented by IA US Large Cap TR Index and bond return by IA US IT Gov Bond TR Index.

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