Recessions carry negative connotations that may incite fear in investors. Such fear can cause investors to react to short-term uncertainty in ways that may be detrimental to long-term wealth creation. Gaining better context about recessions and how they fit into the broader picture of economic progress can help investors weather these difficult periods and take advantage of opportunities when they arise.
1. Is the economy in a recession today?
On a basic level, a recession is a technical way of describing a slowdown, or contraction, in the economy.
Judging by sky-high heating bills, a slumping housing market, and declining stock values, the economy is on shaky ground entering 2023. U.S. gross domestic product (GDP), an aggregate measure of all economic activity in a certain period, contracted in the first two quarters of 2022, which by some definitions indicates the U.S. economy is in a recession. At the same time, the job market remains buoyant and consumer spending, which accounts for more than two thirds of GDP,[1] continues at a solid pace.
U.S. recessions are officially declared by the National Bureau of Economic Research (NBER), which defines recessions as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” To make its determination, the NBER analyzes factors like personal income, employment, personal spending, business sales, and industrial production. According to the NBER, the U.S. economy isn’t in a recession as of early January 2023, but that doesn’t mean we will avoid one.
2. What causes recessions?
Several factors can lead the economy to contract for an extended period, including:
- Hawkish monetary policy: The current cycle highlights one of the primary drivers of a recession—sharply rising interest rates. The U.S. Federal Reserve has increased its benchmark rate by 4.25% since March to curb soaring inflation, the most rapid tightening cycle since the early 1980s. While the Fed hopes to engineer a “soft landing,” where inflation cools without much damage to the economy, the central bank sometimes goes too far in constricting financial conditions, which can lead to an economic slump.
- Too much debt: An overleveraged financial system leaves little margin for error for consumers and businesses. The most recent example is the subprime mortgage and housing collapse in 2008 that negatively impacted homeowners, lenders, and global financial institutions.
- Overvalued assets: When assets like Internet stocks or real estate reach unsustainable levels, the bursting of these bubbles can lead to widespread consequences throughout the economy.
- A “black swan” event: The most recent recession in 2020 lasted only two months, resulting from the global coronavirus outbreak that forced lockdowns and a plunge in economic activity.
3. How frequent are recessions and how long do they last?
Recessions occur regularly and tend to be relatively short-lived. Since 1980, the economy has experienced six recessions, ranging in duration from the two-month coronavirus downturn to the 18-month “Great Recession” from 2007 to 2009. The average recession over that span lasted 10 months.[2]
Expansions, by contrast, tend to have more staying power, lasting an average of 85 months. In fact, the two longest expansions in U.S. history have occurred recently: the 10-year up cycle that commenced in 1991 and ended in 2001, and the nearly 11-year up cycle that began in 2009 and ended with the coronavirus outbreak in early 2020.[3]
4. Do recessions always lead to bear markets?
Stock prices reflect the strength or weakness of company sales and profitability as well as the outlook for those results. During recessions, reduced demand creates revenue and earnings headwinds that can drive stocks into a bear market, which is a decline of 20% or more from a previous peak.
Bear markets have overlapped every recession since 1980 but have not neatly coincided with these downturns. Because the market tends to be a leading indicator of the economy, stocks usually start their recovery ahead of the economy. But recoveries don’t follow a predictable pattern, and the stock market may experience multiple ups and downs before fully recovering from a downturn.
The good news is stocks tend to rebound rapidly from bear market bottoms. Since 1950, the S&P 500 Index has produced a median return of 23.9% in the 12 months following the initial decline.[4]
5. What should investors consider doing during a recession?
It can be tempting to try to take action when portfolio values are falling, but we encourage our clients to stay patient and try to resist the urge to trade unless such moves align with your long-term goals. A better option is to set up a meeting with your advisor, discuss any concerns, and revisit your financial plan.
In addition, market volatility created by recessions may create opportunities to invest in high-quality companies with defensible competitive advantages at attractive valuations.
Another action to consider with your advisor is strategically selling equities through a disciplined rebalancing plan, which can be beneficial from an asset allocation and tax perspective. Exiting stocks that have gone down in value allows for tax-loss harvesting, while trimming or selling out of strong performers may allow you to rotate into other blue-chip stocks that are trading at better relative valuations. It may also make sense to consider a “Roth conversion”—converting a traditional (pre-tax) IRA to a Roth (post-tax) IRA when asset values are depressed and therefore the expected long-term tax impacts are lower.
As always, it is critical to discuss these matters with your advisor to ensure they’re right for you. To discuss what a potential recession means for your financial plan, reach out to your Leelyn Smith advisor today.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
[1] Bureau of Economic Analysis, “National Income and Product Accounts Tables.”
[2] National Bureau of Economic Research (www.nber.org), “US Business Cycle Expansions and Contractions.”
[3] Ibid.
[4] Wall Street Journal, “How the S&P 500 Performs After Closing in a Bear Market” July 14, 2022.