Not all recessions are created equal. Recessions often address economic imbalances. Historically, the Fed has raised interest rates to slow industrial production and reduce excess inventories. More recently, downturns in the U.S. have been prompted by shocks, with the most recent recession caused by dramatic health and government-induced shutdowns. Other recessions began in the corporate sector, and they can come from commodity shocks. The next one could start from geopolitical tensions.
Recessions are sometimes difficult to describe, let alone predict. Definitions vary widely. To make matters worse, some coin their mixed forecasts as a “growth recession.” Recessions are often defined as two consecutive quarters of negative economic growth. However, the 2001 recession was shorter: growth in the first quarter of 2001 declined by 1.3% annualized but between strong quarters with growth above 2%.
The National Bureau of Economic Research (NBER) is the official arbiter of recessions, and their definition is marginally better. “A recession is a significant decline in economic activity spread across the economy and that lasts more than a few months.” The NBER specifically looks at economic indicators such as production and employment. Because the definitions can be elusive and ambiguous, investors should focus on the overall trajectory and economic environment for both businesses and households.
After the Great Financial Crisis, consumers reduced their debt loads (by either paying them down or defaulting). Both the Debt Service Ratio and the broader Financial Obligations Ratio gradually declined and remained steady until the emergence of COVID-19. Government pandemic assistance programs including stimulus and forbearance periods added volatility to consumers’ financial obligations, but if consumers can keep relatively low debt levels, the consumer should successfully manage a period of rising borrowing costs without squelching spending. High savings will help consumers navigate the current inflationary period. Given the uncertainty of the pandemic and generous stimulus measures, deposits grew to roughly $3 trillion above normal levels.
During the crisis when the Federal Reserve (Fed) aggressively cut rates and individuals were highly risk averse, the cost of holding checkable deposits was low so individuals tended to increase savings, thereby adding to bank deposits. Aggregate savings were also bolstered by higher income households who normally spend a larger percentage of discretionary income on services – like travel experiences – but were shut down during the pandemic. Accumulated savings provide a cushion for some consumers during this period of high prices and economic uncertainty. savings will help consumers navigate the current inflationary period.
Employment rebounded from the lows of April 2020 but soon after the beginning of 2021, the rate of job creation slowed. The tight labor market is ripe for the 1.5 million former workers to return on their own terms. Such a high inflationary environment could convince some of these “lost” workers to return. If the economy is continues approaching full employment, the Fed will focus on the mandate for price stability. With the economy slowing on a year over basis, we may see a cooling of both inflation and the job market, which may allow the Fed to pause rate hikes, limiting risks of over tightening. In many previous cycles, the Fed was accused of overtightening and pushing the economy into a hard landing, which is the scenario where unemployment rises and economic growth contracts.
Consumers are likely in a safe space for the current environment, but what about businesses? The National Federation of Independent Business (NFIB) reports that small businesses are adjusting to a variety of current headwinds such as a tight labor market with high quit rates and clogged supply chains pushing up raw material costs. As of March, roughly 50% of small businesses in the U.S. raised compensation to attract and retain workers according to the NFIB. In the same month, over 70% of firms raised prices to cover increased costs. Firms with the ability to pass along cost increases will be able to protect profit margins as labor and material costs increase.
Managers in both services and manufacturing anticipate a slowdown in business, yet still expect growth despite the headwinds from commodity markets and tight labor markets. In fact, both indexes are above 55 – values above 50 indicate expansion. If firms can recalibrate running their business, there may be a rebound in growth the latter half of this year even though the first half might be sluggish.
Not all recessions are the same. Risks remain: the Fed could lose sight of its dual mandate or supply chains remain clogged from Eastern European wars and Asian lockdowns. Inflation could not cool as consumers pivot back from goods-centric
spending (cars and washing machines) to services spending (hotels and airplane tickets). Despite these risks, the metrics above suggest that the economy could escape a recession in the near term, with potential for nearly 3% growth this year.
The views expressedare provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by LPL Financial, tracking #1-05271721.
- Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses.
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- The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.