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I’ve heard there’s going to be a recession. I’ve decided not to participate. –Walt Disney

Defining a recession

Henry Wadsworth Longfellow’s poem, “The Midnight Ride of Paul Revere,” retells the story of a patriot who shouts a harrowing warning to his fellow colonists, “A recession is coming! A recession is coming!” Well, that’s not quite the story, but given the seemingly non-ending talk about a recession, you might think that economists are channeling Paul Revere’s midnight ride. 

Yes, a recession is eventually inevitable, but is it imminent? 

Analysts and short-term traders have become hypersensitive to any signs a recession may be looming. Moreover, the public has taken notice. A quick review of Google Trends bears this out. Google searches for the word “recession” have jumped 61% over the last six months versus the prior five years. However, analysts, short-term traders, and the general public could all be suffering from confirmation bias, the tendency to process information by looking for, or interpreting, information that is consistent with one’s existing beliefs.

What is a recession?

Many people accept the traditional definition of a recession as “two consecutive quarters of negative real (inflation-adjusted) GDP.”  But there are other more useful definitions. An organization called the National Bureau of Economic Research (NBER) is currently the official arbiter of recessions. Founded in 1920, the NBER is a private, nonprofit, nonpartisan organization dedicated to conducting economic research. 

The NBER defines a recession as “a significant decline in activity spread across the economy, lasting more than a few months.” It manifests itself in the data tied to “industrial production, employment, real income, and wholesale-retail sales.” These are very broad categories. So, weakness in one or two sectors does not necessarily indicate a recession. In addition, it’s difficult for the NBER to confirm a recession has begun. It took nearly a year for the NBER to confirm the last recession. By then, it was a forgone conclusion. A similar delay occurs when the economy begins to recover, and the NBER is tasked with calling the end of the recession.

Stock market volatility and the steep correction late last year, the recent slowdown in U.S. economic activity, and an inverted yield curve (see August 2018 Monthly Insight: Don’t Fear the Yield Curve) have all contributed to worries about an economic downturn. Yet, economists have always had trouble forecasting an upcoming recession. A few get it right; most miss it.

Why do we care about recessions?

There are plenty of reasons to care about recession in the economy. For most Americans, job insecurity increases, layoffs rise, and it becomes much more difficult to find work. For investors, it’s a time of heavy uncertainty. Bear marketsa 20% or greater decline in the S&P 500 Index – are typically tied to recessions, as corporate profits decline and companies warn about the future.

Recessions and expansions are a part of the business cycle in a free market economy. But expansions don’t simply fade away. The current economic expansion is fast approaching its 10thanniversary. If the economy is still expanding in July, and odds suggest it will be, the current expansion will become the longest on record, exceeding the expansion of the 1990s, which lasted exactly 10 years.

A cautiously upbeat signal

During the third quarter of 2018, the economy was firing on all cylinders. At the September 2018 meeting of the Federal Reserve, policymakers were projecting three rate hikes in 2019 – all 0.25 percentage point increases. The Fed cut its forecast to two rate increases at the December meeting amid stock market uncertainty and signs U.S. growth was moderating. At the conclusion of the March meeting, the Fed said it sees no rate hikes this year. The markets are now signaling its desire for an interest rate cut this year even though employment remains strong.

It bears repeating that recessions have typically been preceded by major economic imbalances (such as a stock market bubble or housing bubble), or when a sharp rise in inflation forces the Fed to aggressively respond with rate hikes. For the most part, neither condition is currently present, lessening odds a near-term recession is lurking. Further, recent market action has been volatile, but year-to-date performance is still positive in the indexes below. But, perhaps, that’s just confirmation bias.

We hope you found this insight useful. As always, we are honored and humbled you have given us the opportunity to serve as your financial advisor.