A Recession Primer for Recessionary Times
In early 2020, governments confronted the novel coronavirus in an unprecedented way: They locked down economies, intentionally ceasing economic growth—an effort to mitigate face-to-face interaction and thereby limit the pandemic’s spread. As a result, many economies experienced severe negative shocks—posting economic contraction in Q1 2020. Even more seem poised to contract in Q2—to historic degrees—in the first global and US recession since 2009. Given this, here is a primer on recessions: what they are, their relationship with stocks, and what might end or extend those going on now.
There are multiple ways to define recessions. A very common method: two or more consecutive quarters of falling GDP. However, this isn’t the only way—and it isn’t the official one in America. The National Bureau of Economic Research (NBER)—the official arbiter of US recessions—uses a more nuanced, if nebulous, description: “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production and wholesale-retail sales.”[i]
This attempts to capture recessions’ qualitative features while acknowledging their varying duration. For example, NBER designated the US’s 2001 economic downturn as a recession even though GDP didn’t fall for two consecutive quarters (it contracted -1.1% annualized in Q1 and -1.7% in Q3 2001, but it grew 2.4% in Q2).[ii]
If you follow financial news regularly, you may see articles claiming two consecutive quarterly contractions in one economic sector—like energy, manufacturing or housing—constitute an industry recession. In our view, “recession” is the wrong term for these narrower declines. Industries often suffer uniquely from conditions affecting them but not the broad economy. Recession, in our view, refers to overall economic activity.
While recessions recur periodically, they aren’t inevitable and don’t operate on a schedule. Consider Australia, which didn’t experience a recession for nearly 30 years until COVID lockdowns hit.[iii] Meanwhile, Japan endured three recessions between 2009 and the present one.[iv]
While recessions can have several (often simultaneous) causes, they tend to follow widespread overinvestment in ultimately unprofitable ventures. As these fail, businesses typically pull back on investment, production and hiring to focus on survival. A prolonged global yield-curve inversion—when long-term interest rates are below short—can also contribute to recessions, as it makes bank lending less profitable. That tends to lead banks to curtail lending—key fuel needed for businesses to expand.
The 2020 recession isn’t like a traditional recession, in our view. The world wasn’t awash in overinvestment in February 2020. While the global yield curve had flirted with inversion several times in recent years, lending was still growing. The well-intended sudden stop mandated by governments in late February and early March stopped expansion in its tracks.
Although this mostly hit the developed world towards the end of Q1, it was severe enough to tilt Q1 GDP growth negative in many countries. Since lockdowns remained through large chunks of April and May, most countries will likely experience their worst-ever GDP growth in Q2, cementing recession by almost any standard. So much so that NBER, which usually waits many months after a US recession begins before declaring one underway, dubbed the COVID contraction a recession on June 8—before Q2 was even over.
Given stocks are slices of private businesses—many of which are highly sensitive to economic conditions—you may think the fact we are in a recession bodes ill for them. But markets typically look forward, in our view, anywhere from 3 to 30 months. Bear markets—lengthy, fundamentally driven stock market declines of -20% or more—typically begin before a recession is apparent. Stocks usually start recovering long before growth resumes.
For example, US stocks peaked in October 2007. NBER later designated December 2007 as the recession’s start and June 2009 as the end—months after US stocks’ March 2009 low.[v] This year, US stocks’ bull market high was February 19.[vi] Although NBER later said the recession started that month, data revealing the extent of COVID containment-policies’ havoc were still weeks away. Similarly, markets began rising on March 23, 2020—before any economic data hinted at the recovery we are now seeing in measures like retail sales and industrial output.[vii]
Because stocks move first, we think extrapolating a current economic malaise into future market declines is a potentially dangerous investing error. Some of markets’ biggest gains come early in bull markets, so sitting on the sidelines waiting for the economic picture to brighten could mean missing out on a large chunk of their overall return.
Since economic data globally are showing signs of recovery as COVID restrictions (gradually and unevenly) relax, most countries may have already exited recession. That said, many fear a second COVID wave would renew lockdowns and drive contraction anew. This is possible, but even this might not send stocks into another tailspin.
Second-wave worries have been hogging headlines since before governments even started loosening restrictions. Unlike lockdowns’ initial imposition, it likely wouldn’t shock investors unless renewed closures are unexpectedly broad-based and extreme. In this way, forward-looking markets could rise even if economic activity resumes contracting—a counterintuitive point of which, in our opinion, many investors should be aware.
Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.
[i] Source: National Bureau of Economic Research, as of 07/02/2020.
[ii] Source: Bureau of Economic Analysis, as of 07/09/2020.
[iii] Source: FactSet, as of 07/17/2020.
[v] Source: National Bureau of Economic Research and FactSet, as of 07/15/2020. S&P 500 total return index, 10/09/2007–03/09/2009.
[vi] Source: National Bureau of Economic Research and FactSet, as of 07/15/2020. S&P 500 total return index peaked on 02/19/2020.
[vii] Source: National Bureau of Economic Research and FactSet, as of 07/15/2020. S&P 500 total return index, US retail sales in May and June 2020 and US industrial production in May and June 2020.