Recession and GDP

Question: Can you discuss what a recession is and if we’ll enter one?

Answer:  

The textbook definition of a recession is two consecutive quarters of negative gross domestic production (GDP). During the first quarter of 2022, GDP was down by an annual rate of 1.5%. In comparison, the fourth quarter 2021 GDP number was a positive 6.9%. Whatever the classic description of a recession is, we are experiencing a significant decline in economic activity. 

To help understand the methodology and reporting, let’s identify what goes into the GDP report calculations. GDP consists of personal consumption expenditures (durable and non-durable goods and services), plus domestic investment (residential, nonresidential and changes in inventories), plus federal, state, and local government consumption and gross investment and the net total of exports minus imports. 

A negative GDP number is not ideal. Many factors contributed to recent changes to economic activity. The most obvious are global inflation, higher interest rates, supply chain struggles, huge increases in the money supply, China’s zero-Covid policy and higher oil prices. It’s no wonder that we’re feeling the effects of an economic slowdown.

Consumption is the largest of the four GDP components accounting for approximately 70% of the total. Employment and wages drive consumer expenditures. Price inflation remains a strong headwind and why we pay close attention to the rate that inflation is rising or slowing. As this is being written, unemployment stands at 3.6% with over 11 million jobs available. A steady stream of income for consumers fuels spending.

Consumer confidence is another factor to watch as it influences behavior. Higher prices reduce purchasing power. With consumption as the largest contributor to GDP, private domestic investments are a component to watch and assess for growth or slowdowns. When the economic outlook deteriorates, companies and individuals tend to decrease their investments and increase inventories and savings. Reductions in spending and heavier inventories are often the first signs of recession. 

Will there be a recession in the U.S. and when will that be? We don’t know. The U.S. economy is resilient. If a recession were to occur, it is likely that it will not be as strong as the Great Recession of 2007-2009, but rather a mild economic slowdown. Inflation remains as a detrimental factor to economic growth. Until there is a contraction in our money supply, and resolution on the international stage between Russia and Ukraine, and China’s policies, we are dealing with uncertainty until inflation improves. The war in Ukraine will have a bigger impact on Europe’s economy than in the U.S.

Inflation is a big risk for policy makers as the Federal Reserve became more aggressive in its campaign to raise interest rates. Nonfarm payrolls are still below where they were before the pandemic while economic growth is expected to continue but at a slower pace. Business fixed investment and manufacturing growth have slowed, yet export growth supports expansion. Expect GDP growth to moderate as consumer demand slows. The Fed’s course of action will influence the economic outlook as well. If the Fed over does rate increases, the likelihood of a recession increases.

It’s likely that the U.S. economy will eventually enter a recession with markets already pricing in this probability. The biggest question is whether the Fed can engineer a “soft landing,” which is slowed economic growth to combat inflation, while not completely stopping growth. No two recessions are the same with expansions and recessions being fundamental components of business cycles. According to the National Bureau of Economic Research (NBER), since 1990 there have been four recessions which all led to future growth.

While a negative GDP reading is not ideal, having the resources in place to navigate choppy markets is a prudent plan. Market volatility will remain as long as there is uncertainty. As Miguel de Cervantes so aptly said, “To be prepared is half the victory.” Stay focused and plan accordingly.