Over the next few months, we are going to hear a lot about a recession, and in most cases accompanied by a qualifier such as: “unlikely recession”, “certain recession”, or my favorite that comes out in a couple of years, “the recession that everyone knew was going to happen.”
After the Federal Reserve began raising its Federal Funds discount rate, the headlines predictably shifted to guess whether these actions would cause an economic slowdown and a recession.
Terms such as “soft landings”, “hard landings”, and “implied interest rates” may be thrown around to make people sound smarter. While it can be interesting to hypothesize about a recession, we should look at history. Determining whether or not the current economic data officially places us in a recession is not always helpful information for investors and the decisions they make regarding their portfolios.
A recession is a period of declining real growth for at least two quarters (six months). The “real” is important because it discounts the growth rate by the current inflation rate.
In the first quarter of 2022, nominal GDP gained about 6.5%, but because inflation grew at 8%, the real growth rate was a decline of -1.5%. The economy slowed down. Economic headwinds have persisted throughout the first two months of the second quarter, leading some to fear the economy may be entering into a recession if certain trends continue.
Or, perhaps we were already in a recession. “So you’re telling me that we might already be in a recession?” Actually, by the time you read this article, we might have already been through a recession. Even though the Fed only provides GDP data quarterly, other metrics measure the economy’s strength on a more frequent basis.
According to IHS Markit, part of S&P Global, the previous six months of GDP data from November through April was -0.6%, 0.0%, -0.1%, +0.1%, -0.3%, and +0.5%, respectively. This combines to a -0.4% contraction. Even though it does not align with the calendar quarter on which the Fed reports, according to this data, it is possible that we were already experiencing six months of declining real growth that began sometime in October.
While still too early to tell, forecasts call for a positive growth rate in the second quarter. If this is the case, the recession of 2021-22 would already be over almost before it ever began.
This doesn’t mean that another recession isn’t headed our way. The point is that recessions are often only known after the fact using hindsight. GDP numbers are a lagging indicator. They tell us what happened. Not what will happen.
We will likely only know about the next recession after data confirms it took place, usually several months later. It does not provide very useful information for investors to draw for their investment decisions.
What information is more timely? Market behavior and price action tell us more about what will happen in the economy. When we are told that the economy is officially in a recession, it is too late to sell and the markets have likely already started to recover.
According to Ned Davis Research, on average, the S&P 500 will reach its bottom before a recession becomes official. Additionally, by the time the recession has ended, the S&P 500 is higher than when the recession began.
How often have you heard someone predict the market had peaked, only to continue to see the market post solid gains over the next few months, quarters, and years? Trying to time the market and predict big swings is a fool’s errand and will typically lead to less than desirable outcomes. Making it even tougher, headlines and other lagging economic data points will often be dire, even as the market is already beginning to move higher.
We may be headed for a recession or we may have just come through one. Rather than trying to time the market, sticking with a long-term investment strategy that focuses on your goals and needs continues to be our recommended approach to successful long-term investing.
As the summer plays out, you will hear a lot of talk about a recession. Remember how markets have historically behaved and keep your long-term plan in mind.
Bill Wendling is a Senior Portfolio Manager with Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.bedelfinancial.com or email Bill at firstname.lastname@example.org.