Are we in a recession? Finding an answer can be tricky. Learn what a recession is, how long they last and what investors should do when they happen.
"Never miss out on an opportunity like a recession" — Jack Welch, former chairman and CEO of General Electric (NYSE:GE).
In an effort to combat runaway inflation, the US Federal Reserve, along with other central banks around the world, has begun hiking interest rates — and if Chair Jerome Powell has his way, these increases are set to continue. But as most economists will tell you, central banks don’t have the best track record for curbing inflation without summoning a recession.
“Since the post-war era, the vast majority of federal tightening cycles do end up in a recession. So this has to be the base case this time,” said Chris Wood, head of equity strategy at Jefferies Hong Kong, during his keynote presentation at the recent Gold Forum Americas. Wood expects a recession to materialize in the US by mid-2023.
Others believe the country has already entered a recession — US gross domestic product (GDP) contracted by 1.6 percent in the first quarter of 2022, followed by a 0.6 percent contraction in the second quarter. Two consecutive quarters of declining GDP is often considered the most important signal that a recession has arrived.
Aside from GDP, another key metric for the health of the economy is the price of copper. The red metal is the most widely used of the base metals, from the construction industry and electronics to electric vehicles and charging stations.
Its recent price activity doesn't bode well. Trading Economics reported in early October that “copper declined for the sixth straight month in September and is still trading about 30 (percent) below this year’s high as aggressive monetary tightening by major central banks aimed at curbing inflation sparked fears of a global economic slowdown that could hurt commodities demand.”
Despite these and other factors, some are reluctant to even say the word "recession." In a mid-October interview with CNN, US President Joe Biden said he doesn't expect a recession in the near term, and if there is it will only be "a very slight recession."
So — are we in a recession? Even though nailing down an answer is tricky, investors can get educated on what a recession is, how long they last and what strategies may work well during these difficult economic periods.
What is a recession?
When a country’s economic activity experiences a serious and persistent decline over an extended period, often over two consecutive quarters, economists call it a recession. Some of the key indicators of a recession include rising unemployment levels, negative GDP, stock market selloffs and falling manufacturing data, as well as declining consumer confidence as evidenced by dropping retail sales. Recessions involve a broad array of economic sectors, not just a decline among one or two industries.
Answering the question, "Are we in a recession?" is difficult because so many factors are at play — while one expert might weigh GDP declines heavily, another might feel other elements are more important.
Watch the video below to get a sense of why getting a consensus can be tough.
Experts Rick Rule, Adrian Day and Mike Larson explain why it's hard to get an answer on whether the US is in a recession.
What causes a recession?
Forbes lists a number of catalysts that can spark a recession: sudden economic shock, excessive debt (think the US mortgage debt crisis that fueled the Great Recession in 2008), asset bubbles, uncontrolled inflation (which leads central banks to raise interest rates, making it more expensive to do business or pay down debts), runaway deflation and technological changes.
Are there signs before a recession?
What are the tell-tale signs that warn of a recession in advance? Much like the weather, making any sort of economic forecast is difficult. But there are certain signals economists look out for.
Aside from the previously mentioned slumping GDP and falling copper prices, declining unemployment figures, shrinking industrial output and falling retail sales are classic indicators of a potential recession.
Another fail-safe harbinger of a looming recession is an inverted bond yield curve. “The bond market can help predict the direction of the economy and can be useful in crafting your investment strategy,” Investopedia states. “This metric — while not a guarantee of future economic behavior — has a strong track record.”
How long do recessions last?
Recessions are considered a part of the normal expansions and contractions of the business cycle. While not as catastrophic as depressions, recessions can last for several months and even years, with significant consequences for governments, companies, workers and investors. Each of the four global recessions since World War II lasted about one year.
That said, there have been a few short-lived recessions in the US, including the 2020 pandemic recession. Stock markets around the world crashed at the onset of the COVID-19 outbreak. A record 20.5 million jobs were lost in the US alone in April 2020 as the nation’s unemployment rate reached 14.7 percent.
The Fed responded by cutting interest rates, and the US federal government issued trillions of dollars in financial aid to laid-off workers and impacted businesses. By October 2020, US GDP was up 33.1 percent, marking an end to the recession.
What sectors will be hit hardest by the upcoming recession?
Businesses often tighten their belts during recessions by postponing expansion plans, reducing worker hours and benefits or laying off employees. Those same workers are the consumers that play a vital role in the strength of a nation’s economic activity.
With less disposable income, consumers stop spending on large appliances, vehicles, new homes, evenings out and vacations. The focus shifts to low-priced necessities, food and medical needs. Declining consumer spending and demand for goods and services pushes the economy into a deeper recession, resulting in more layoffs and rising unemployment. Small- and medium-sized business owners may even find themselves unable to operate entirely.
Typically, retail, manufacturing, restaurants, technology, travel and entertainment are hit the hardest during a recession. The real estate and mortgage lending sectors may also feel the pain.
As the recession worsens, some homeowners may not be able to pay their mortgages and may face defaults, which can bring further downward pressure on real estate prices. Those still shopping for a home or new car may find that banks have instituted much tighter lending policies on mortgages and car loans. Meanwhile, investors can lose money as their stock holdings and real estate assets lose their value. Retirement savings accounts linked to the stock market can also suffer.
All of these forces can contribute to a deflationary environment that leads central banks to cut interest rates in an effort to stimulate the economy out of a recession.
How to prepare for a recession?
There is no perfect answer for how to invest during a recession, and no stock remains recession-proof. But for those who know how to practice due diligence through fundamental analysis, recessions do offer an opportunity to pick quality stocks at a discount.
“The stock market is the only store where when things go on sale, everyone runs out the door. You don’t want to be one of those people,” said Shawn Cruz, head trading strategist at TD Ameritrade. “So if you have a long term focus and some specific names you’re looking at, this is a good time to pick up some quality shares for your portfolio.”
It’s better to look at well-established publicly traded companies with strong balance sheets and minimal debt that still have the ability to generate cash and pay dividends. Companies to avoid include those with a high debt load and little cash flow, as they have a difficult time managing operating costs and debt payments during recessions.
Industry matters, too. As mentioned above, the real estate, retail, manufacturing, restaurants, technology, travel and entertainment are hit the hardest during a recession. On the other hand, stocks in the consumer staples (food and beverage, household goods, alcohol and tobacco) and healthcare (biotech and pharmaceutical) sectors tend to do well in recessionary environments. Once the market is in recovery, technology stocks seem to benefit the most.
Inventors can further mitigate the risks that a recession brings by building a diversified portfolio that considers stocks across varying sectors and geographic regions. Rather than investing in individual stocks, exchange-traded funds with low management fees are another way to spread risk. The Vanguard Consumer Staples ETF (NYSEARCA:VDC) or the Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP) are two examples to consider.
What assets can hold their value in a deep recession?
For long-term investors looking to ride out the worst recessions, stocks and high-yield bonds are best avoided. Safer assets that have historically performed well during recessions include government bonds, managed futures, gold and cash.
If you've parked your dollars in actual dollars, i.e. cash, instead of the stock market, the value is not being erased by declining stock prices. The "cash is king" mantra speaks to the importance of keeping liquid assets on hand during a recession.
Along that same vein, gold has earned its safe-haven status because it is a physical asset that holds its value and can be easily liquidated. “People want to hold a physical commodity that has inherent value and can hold that value when equities decline,” said Ed Egilinsky, head of alternative assets at New York-based exchange-traded fund and mutual fund company Direxion Investments.
One last thought — don't move all your wealth into gold or cash. A diversified portfolio is still the best hedge against a recession.
Don't forget to follow us @INN_Resource for real-time updates!
Securities Disclosure: I, Melissa Pistilli, hold no direct investment interest in any company mentioned in this article.
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