Category Archives: Recession

Interest Rates, Cost of Capital and Recession

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Interest rates are often called the price of money. They determine how expensive capital is to access for companies, but also for individuals and even governments. ~ Jonathan Schramm

The Federal Reserve controls what is called the federal funds rate, which is the rate banks pay to borrow from other banks. Other interest rates throughout the system are based on that rate.

When an economy is in recession or unemployment is high, the Fed lowers rates. This is meant to encourage investment and spending, pushing more money into the economy.

Inflation is a sign there is too much money in the financial system and economy. One way to reduce the monetary supply is to give people and businesses an incentive to take on less debt. A good way to do that is to raise rates. And this is just what the Federal Reserve is doing.

Interest rates affect stocks in two main ways: the impact companies’ bottom line and impact investor’s behavior.

Many companies “roll over” their debt. This means they never really pay their debt, just pay the interest and renew their old bonds with new ones. In this case, rising rates mean the new bonds will cost the company a lot more in interest expenses going forward.

Some companies are also highly reliant on cheap debt to keep afloat or grow. Others rely on customers spending on credit cards. These companies’ profits might suffer in an environment of rising rates.

This is why a rising rate environment favors skilled stock pickers. A solid balance sheet, low debt, cheap valuation, or high profitability will be very valuable in an environment of rising rates.

Higher interest rates are a disincentive for investors to plow borrowed money into asset markets. That’s one of the main reasons why stocks, cryptocurrencies, and other assets crashed in 2022.

Rising rates for borrowed money tends to cause capital flow out of markets, depressing the values of even quality companies. That hurts investors who bought at the top, especially if they bought at the top with borrowed money. For others it creates a valuable entry point.

Overall, rising interests rates and tightening the money supply are a useful tool to help bring inflation under control. But the recent interest rate increase might not have been enough and there’s probably more to come. If inflation stays high, we would need rates continue to rise to curb inflation.

The positive aspects for US investors:

  • Rising rates support a stronger dollar.
  • A strong dollar makes US imports cheaper.
  • A strong dollar support consumers’ spending by decreasing import costs.
  • Rising rates might help to keep inflation under control.

The negative aspects for US investors:

  • Currency devaluation can hurt overseas investments measured in USD.
    Overindebted companies and consumers might not be able to manage higher rates.
  • Rising rates decrease demand for big-ticket items like homes and vehicles.
  • Rising rates increase the risk of a recession.
  • Rising rates make US exporters less competitive.
  • Rising rates restrict the use of borrowed money by investors, decreasing demand for assets across the board.vehicles.
  • Rising rates increase the risk of a recession.
  • Rising rates make US exporters less competitive.
  • Rising rates restrict the use of borrowed money by investors, decreasing demand for assets across the board.

References:

  1. https://finmasters.com/rising-interest-rates-effects/

Are American Consumers in a Recession?

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Over the past few months, supply-chain headwinds, inflationary pressures, inverted U.S. Treasury bond yield curve, and rising interest rates has added friction to the U.S. economy and to business operations across industries.

Consequently, investors have become extremely pessimistic about the economic outlook and stock market sentiment, which both are expected to witness a downturn in 2023 amid the impending prospects of a recession.

Per JPMorgan Chase, rising interest rates, record decades high inflation, geopolitical pressure and other factors could lead to a recession that will likely wash away the benefits of savings and the massive government aid received during the pandemic. Moreover, the job market is expected to downshift significantly and unemployment is projected to increase next year as the economy weakens.

A growing number of companies are opting to leave jobs vacant when employees leave or announcing hiring freezes. Widespread layoffs so far have been limited to the handful of industries hammered by rising interest rates, such as technology, housing and finance, say Mark Zandi, chief economist of Moody’s Analytics, and Jim McCoy, senior vice president of talent solutions for ManpowerGroup, a staffing firm.

The Federal Reserve, by increasing its benchmark interest rate to counter inflation, has raised the possibility of a downturn next year. Some experts believe that the Federal Reserve’s bid to contain inflation by increasing interest rate and tightening the money supply will likely achieve its target but put pressure on the consumer’s wallet and potentially trigger a recession in 2023.

Fifty-seven percent of the National Association for Business Economics (NABE) economists see more than a 50% chance of recession next year, according to the results of a new survey published by NABE. The survey pointed to the Federal Reserve’s continued raising the federal funds rate and tightening of monetary policy in an effort to tame inflation as the biggest challenge facing the economy.

Additionally, Gregory Daco, chief economist of EY-Parthenon, expects a recession to hit by the first half of 2023 as hiring slows and layoffs spread across industries, leading to net job losses for the year. He expects the economy to grow just 0.3% for the full year and unemployment to peak at 5.5%.

Many Americans believe that the U.S. economy and the global economy are already in a recession. However, with consistently strong job growth, historically low unemployment and solid growth in consumer spending, that doesn’t sound like a recession most people would remember.

But, a recession is in the eyes of the beholders. Essentially, “It depends on who you ask,” says Capital Group economist Jared Franz. “With food, energy and shelter prices all rising faster than wages, the average American consumer would probably say yes. In my view, we are either on the edge of a recession or we are already tipping into it.”

To put things in perspective, over the past 70 years the average U.S. recession has lasted about 10 months and resulted in a GDP decline of 2.5%. In Franz’s estimation, the next one may be worse than average, if current trends persist, but still less severe than the Great Recession from December 2007 to June 2009.

Key economic indicators point to a potential recession

Sources: Capital Group, Bureau of Economic Analysis, National Bureau of Economic Research, U.S. Department of Commerce.

The official arbiter of U.S. recessions, the National Bureau of Economic Research (NBER) considers many factors beyond GDP, including employment levels, household income and industrial production. Since NBER usually doesn’t reveal its findings until six to nine months after a recession has started, we may not get an official announcement of an economic recession until next year.

“It’s fair to say that most consumers probably don’t care what NBER thinks,” says Capital Group economist Jared Franz. “They see inflation above 9%, sharply higher energy prices and declining home sales. They feel the impact of those data points. The labor market is one of the only data points that isn’t signaling a recession right now.”

References:

  1. https://www.cnbc.com/2022/12/06/recession-walmart-jpmorgan-gm-ceos-talk-about-possible-slowdown.html
  2. https://www.msn.com/en-us/money/markets/is-a-2023-recession-coming-job-growth-likely-to-slow-sharply-companies-brace-for-impact/ar-AA159tMa
  3. https://www.foxbusiness.com/economy/labor-market-may-skirt-us-recession-nabe
  4. https://www.capitalgroup.com/advisor/insights/articles/is-us-already-in-recession.html

The Impact of Increasing Interest Rates on the Economy and Investing

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The Federal Reserve Bank (Fed) implements monetary policy that has a broad impact on the US economy. One of the ways the Fed impacts its dual mandate of managing unemployment and inflation is to periodically raise or lower interest rates.

The Federal Reserve in November 2022 raised interest rates by three-quarters of a percentage point — or 75 basis points — for the fourth time in the calendar year, bringing its key benchmark borrowing rate that rules all other interest rates in the economy up to a target range of 3.75-5 percent, where it hasn’t been since early 2008, according to a Bankrate.

The fed funds rate matters because it has ripple effects on every aspect of consumers’ financial lives, from how much they’re charged to borrow to how much they earn in interest when they save. And, changing interest rates is one of the main tools that the Fed can use to cool down inflation.  

Inflation is the increase in the prices of goods and services over time and occurs when the demand for those goods and services exceeds supply. Inflation also represents a loss of purchasing power.

Typically, the Fed raises interest rates in times of economic expansion and does so to prevent the economy from overheating. The opposite is true when interest rates are cut, which typically occurs when the economy is in a down trend. 

To raise interest rates, the Fed changes the overnight rates at which it lends money to banks. That sets off a chain reaction that impacts the rates banks charge to businesses and individuals. When rates rise, the impact on the economy includes:

  • Borrowing costs rise for businesses, which can reduce investments in new plants, equipment, marketing, and physical expansion.
  • Borrowing costs rise for consumers, which reduces consumer spending, home buying, and investing.
  • Savings accounts and other low-risk investments earn more interest, making investing in low-risk instruments more attractive.

Markets adjust, with fixed income securities generally reducing in value and equities reacting in a mixed fashion depending on how much a rate rise is expected to affect specific types of businesses.

The U.S. Interest Rate Historical Timeline

The chart below shows the history of Fed Funds Rates going back to 1954.

The U.S. Interest Rate Historical Timeline The chart below shows the history of Fed Funds Rates going back to 1954.

Chart of Fed Funds Rate (Macrotrends)

Rising interest rates impact investing in several ways, some of which are fundamental and some of which are perceptual.

Adding to the dilemma for many investors is the inflation outlook and the question of how transitory or persistent that inflation will be. From a rate perspective alone, rising rates can be expected to have the following impact:

  • Prices of bonds and other fixed-income investments will weaken with rising rates, especially the longer-term instruments.
  • Rates offered on new bonds will rise, making them somewhat more competitive with equities.
  • Rates should rise in bank products such as CDs, bringing them back on the radar for investors.
  • When rates rise, stocks tend to fall — when rates fall, stocks rise.

Equity market reactions will be mixed, depending on the effects of higher rates on different companies and industries. Companies that are more leveraged will incur higher costs. Companies with high-ticket products that rely on consumer credit may weaken. On the whole, rising rates should also dampen enthusiasm to speculate, given higher borrowing costs.

“When interest rates are low, companies can assume debt at a low cost, which they may use to add team members or expand into new ventures,” says Brenton Harrison, CFP® professional based in Nashville, TN. “When rates rise, it’s harder for companies to borrow and more costly to manage what debt they already have, which impacts their ability to grow,” he adds. These higher costs may result in lower revenues, thus negatively impacting the value of the company.

Also keep in mind that as rates fall on savings accounts and certificates of deposit, investors generally seek out higher paying investments like stocks and are generally seen as a catalyst for growth in the market; in a rising rate environment investors tend to shift away from stock to places with less risk and safer returns. 

The specter of rising rates can also change the behavior of investors, many of whom may decide to put off purchases on credit or sell stocks that were purchased on margin, based more on their expectations than on near-term reality.

“Central banks tend to focus on fighting the last war,” says Scott Sumner, monetary policy chair at George Mason University’s Mercatus Center. “If you have a lot of inflation, you get a more hawkish stance. If you’ve undershot your inflation target, then the Fed thinks, ‘Well, maybe we should’ve been more expansionary.’”

References:

  1. https://seekingalpha.com/article/4503025-federal-reserve-interest-rate-history
  2. https://www.bankrate.com/banking/federal-reserve/history-of-federal-funds-rate/
  3. https://www.businessinsider.com/personal-finance/how-do-interest-rates-affect-the-stock-market

Recession and Investing

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A recession is a period of economic contraction. Recessions are typically accompanied by falling stock markets, a rise in unemployment, a drop in income and consumer spending, and increased business failures. ~ SoFi

Liz Young, Head of Investment Strategy at SoFi, talks recession.

A recession describes a contraction in economic activity, often defined as a period of two consecutive quarters of decline in the nation’s real Gross Domestic Product (GDP) — the inflation-adjusted value of all goods and services produced in the United States. However, the National Bureau of Economic Research, which officially declares recessions, takes a broader view — including indicators like wholesale-retail sales, industrial production, employment, and real income.

Recessions tend to have a wide-ranging economic impact, affecting businesses, jobs, everyday individuals, and investment returns. But what are recessions exactly, and what long-term repercussions do they tend to have on personal financial situations? Here’s a deeper dive into these economic contractions.

It’s worth remembering some investments do better than others during recessions. Recessions are generally bad news for highly leveraged, cyclical, and speculative companies. These companies may not have the resources to withstand a rocky market.

By contrast, the companies that have traditionally survived and even outperformed during a downturn are companies with very little debt and strong cash flow. If those companies are in traditionally recession-resistant sectors, like essential consumer goods, utilities, defense contractors, and discount retailers, they may deserve closer consideration.

During a recession, it’s important to remember two key tenets that will help you stick to your investing strategy.

  1. The first is: While markets change, your financial goals don’t.
  2. The second is: Paper losses aren’t real until you cash out.

The first tenet refers to the fact that investors go into the market because they want to achieve certain financial goals. Those goals are often years or decades in the future. But as noted above, the typically shorter-term nature of a recession may not ultimately impact those longer-term financial plans. So, most investors want to avoid changing their financial goals and strategies on the fly just because the economy and financial markets are declining.

The second tenet is a caveat for the many investors who watch their investments — even their long-term ones — far too closely. While markets can decline and account balances can fall, those losses aren’t real until an investor sells their investments. If you wait, it’s possible you’ll see some of those paper losses regain their value.

So, investors should generally avoid panicking and making rash decisions to sell their investments in the face of down markets. Panicked and emotional selling may lead you into the trap of “buying high and selling low,” the opposite of what most investors are trying to do.

Stay the course and stick to your financial plan to survive a recession!

Source: https://www.sofi.com/learn/content/investing-during-a-recession/

6 Common Causes of Recessions

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“A soft landing is impossible. The economy is going to go into a recession fast. You’re going to see the economy just screech to a halt. That’s what the Fed needs to do to get inflation down.” ~ Mike Novogratz, Galaxy Digital CEO

The causes of recessions can vary greatly, according to the FinTech company Sofi. Generally speaking, recessions happen when something causes a loss of confidence among businesses and consumers. The recession that occurred in 2020 could be considered an outlier, as it was mainly sparked by an external global health event rather than internal economic causes.

The mechanics behind a typical recession work like this: consumers lose confidence and stop spending, driving down demand for goods and services. As a result, the economy shifts from growth to contraction. This can, in turn, lead to job losses, a slowdown in borrowing, and a continued decline in consumer spending.

According to SoFi, here are some common causes of recessions:

1. High Interest Rates

High interest rates make borrowing money more expensive, limiting the amount of money available to spend and invest. In the past, the Federal Reserve has raised interest rates to protect the value of the dollar or prevent the economy from overheating, which has, at times, resulted in a recession.

For example, the 1970s saw a period of stagnant growth and inflation that came to be known as “stagflation.” To fight it, the Fed raised interest rates throughout the decade, which created the recessions between 1980 and 1982.

2. Falling Housing Prices

If housing demand falls, so does the value of people’s homes. Homeowners may no longer be able to tap their house’s equity. As a result, homeowners may have less money in their pockets to spend, reducing consumption in the economy.

3. Stock Market Crash

A stock market crash occurs when a stock market index drops severely. If it falls by at least 20%, it enters what is known as a “bear market.” Stock market crashes can result in a recession since individual investors’ net worth declines, causing them to reduce spending because of a negative wealth effect. It can also cut into confidence among businesses, causing them to spend and hire less.

As stock prices drop, businesses may also face less access to capital and may produce less. They may have to lay off workers, whose ability to spend is curtailed. As this pattern continues, the economy may contract into recession.

4. Reduction in Real Wages

Real wages describe how much income an individual makes when adjusted for inflation. In other words, it represents how far consumer income can go in terms of the goods and services it can purchase.

When real wages shrink, a recession can begin. Consumers can lose confidence when they realize their income isn’t keeping up with inflation, leading to less spending and economic slowdown.

5. Bursting Bubbles

Asset bubbles are to blame for some of the most significant recessions in U.S. history, including the stock market bubble in the 1920s, the tech bubble in the 1990s, and the housing bubble in the 2000s.

An asset bubble occurs when the price of an asset, such as stock, bonds, commodities, and real estate, quickly rises without actual value in the asset to justify the rise.

As prices rise, new investors jump in, hoping to take advantage of the rapidly growing market. Yet, when the bubble bursts — for example, if demand runs out — the market can collapse, eventually leading to recession.

6. Deflation

Deflation is a widespread drop in prices, which an oversupply of goods and services can cause. This oversupply can result in consumers and businesses saving money rather than spending it. This is because consumers and businesses would rather wait to purchase goods and services that may be lower in price in the future. As demand falls and people spend less, a recession can follow due to the contraction in consumption and economic activity.

How Do Recessions Affect You?

Businesses may have fewer customers when the economy begins to slow down because consumers have less real income to spend. So they institute layoffs as a cost-cutting measure, which means unemployment rates rise.

As more people lose their jobs, they have less to spend on discretionary items, which means fewer sales and lower revenue for businesses. Individuals who can keep their jobs may choose to save their money rather than spend it, leading to less revenue for businesses.

Investors may see the value of their portfolios shrink if a recession triggers stock market volatility. Homeowners may also see a decline in their home’s equity if home values drop because of a recession.

When consumer spending declines, corporate earnings start to shrink. If a business doesn’t have enough resources to weather the storm, it may have to file for bankruptcy.

Governments and central banks will often do what they can to head off recession through monetary or fiscal stimulus to boost employment and spending. “It’s hard to not underestimate the huge impact that the response to COVID-19 had on all assets. We pumped so much liquidity into the markets it was crazy, we had never seen anything like it. We were throwing trillions of dollars around like matchsticks,” said Mike Novogratz, Galaxy Digital CEO.

Central banks, like the Federal Reserve, can provide monetary policy stimulus. The Fed can lower interest rates, which reduces the cost of borrowing. As more people borrow, there’s more money in circulation and more incentive to spend and invest.

Source: https://www.sofi.com/learn/content/what-is-a-recession/

Will Higher Interest Rates Tame Inflation?

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Interest rates don’t determine inflation; the amount of money circulating in the economy determines inflation.  At this point, there are over $5 trillion in excess money in the system. Brian Wesbury

While inflation roars at its highest level in four decades, President Joe Biden tried to downplay skyrocketing inflation, insisting it was only up “just an inch” in the short term.

“Well, first of all, let’s put this in perspective. Inflation rate month to month was just– just an inch, hardly at all,” President Joe Biden on Sixty Minutes

Despite the fact that consumer prices rose in August by one-tenth of a percentage point to 8.3 percent, economists had expected inflation to go down. Additionally, median inflation hit the highest level ever recorded.

The median CPI, which excludes all the large changes in either direction and is better predicted by labor market slack, is extremely ugly at 9.2% annual rate in August, the single highest monthly print in their dataset which starts in 1983 (second highest was in June).

The Federal Reserve has been raising interest rates since March to slow the economy in a bid to tame America’s worst bout of inflation in four decades. However, the data suggested that their efforts have not yet had much of an effect.

The Federal Reserve raising interest rates may reduce economic growth, make capital more expensive and may throw the US economy into recession, however there is no guarantee that these actions will tame or fix inflation, opines Brian Wesbury, Chief Economist, First Trust Advisors L. P. Interest rates, supply disruptions or Russian’s war in Ukraine don’t determine inflation; the amount of money circulating in the economy determines inflation.  

“Inflation is always and everywhere a monetary phenomenon.” ~ Milton Friedman

The Fed’s balance sheet held $850 billion in reserves at the end of 2007.  Today, the balance sheet is close to $9 trillion.  Most of these deposits at the Fed are bank reserves which the Fed created by buying Treasury bonds, much of which was money the Treasury itself handed out during the pandemic.  At this point, there are over $5 trillion in excess money in the system.

Technically, banks can do whatever they want with these reserves as long as they meet the capital and liquidity ratio requirements set by regulators.

  • They can hold them at the Fed and get the interest rate the Fed sets, or
  • They can lend them out at current market interest rates.  

In turn, the big question is whether the Fed can pay banks enough to stop them from lending in the private marketplace and multiplying the money supply.

The Fed has never tried to stop bank lending in an inflationary environment by just raising the interest rate on excess reserves (IOER). Moreover, the Fed is now losing money on much of its bond portfolio because it bought so many bonds at low interest rates. At some point the Fed will be paying out more in interest than it is earning on its securities.

Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today.

References:

  1. https://www.ftportfolios.com/Commentary/EconomicResearch/2022/9/19/will-higher-interest-rates-tame-inflation
  2. https://www.breitbart.com/economy/2022/09/13/underlying-inflation-reaches-scorching-new-record-high/

“Taxes now impose a greater burden on the average American household than the combined cost of food, clothing, education, and health care.”

How to Protect Your Money from Inflation

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Inflation causes your money to be worth less over time. To hedge against inflation, you need to invest your money in assets.

Inflation in the U.S. is at the highest rate in four decades.

Inflation decreases the purchasing power of your dollars over time. Here are steps you can take to protect the purchasing power of your dollars, according to Forbes.

  • Trim your expenses. To minimize the impact of inflation, review your spending and identify areas to reduce or eliminate completely.
  • Wait to pay off low-interest debt. Paying off debt is usually good, but you may want to hold off on making extra payments if you have low-interest debt. Your debt becomes less expensive due to inflation. Use the money for other purposes—like paying off higher-interest loans.
  • Invest your money. Inflation causes your savings to be worth less over time. To hedge against inflation, you need to invest your money. If the prospect of investing is scary, consider a diversified portfolio of broad market index funds to lower your risk levels and costs.

Getting inflation under control

The Federal Reserve is tasked with keeping inflation at a healthy level by adjusting the nation’s money supply and interest rates.

When the economy is expanding too quickly and inflation rises, the Fed will typically raise interest rates or sell assets to reduce the amount of cash in circulation. These actions tend to reduce demand within the economy and can push the economy into recession.

References:

  1. https://www.forbes.com/advisor/investing/is-inflation-good-or-bad/

Federal Reserve Balance Sheet and Inflation

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The U.S. Federal Reserve’s balance sheet consists of the Fed’s portfolio of U.S. Treasury and government-guaranteed mortgage-backed securities (MBS).

The balance sheet is one of the Federal Reserve’s main instruments for conducting monetary policy and for fulfilling the Federal Reserve’s dual mandate that requires it to ensure both stable prices and maximum employment.

The traditional tool the Fed used to accomplish these goals was the adjustment of the federal funds rate, the short-term interest rate that determined how much it costs for banks to lend to each other overnight.

The 2007-2008 financial crisis, however, demonstrated that even lowering the interest rate to zero was considered insufficient to shore up economies in freefall, and the Fed turned to more unusual tactics.

One of these measures was what the Fed refers to as “large-scale asset purchases,” which is more commonly known as “quantitative easing.” Just as with any other firm, securities that the Fed purchases through quantitative easing are considered assets and therefore are represented on the Fed’s balance sheet.

The value of the balance sheet of the Federal Reserve increased overall since 2007, when it stood at roughly $0.9 trillion U.S. dollars.

As of September 6, 2022, the Federal Reserve had $8.82 trillion U.S. dollars of assets on its balance sheet.

This dramatic increase can be traced back to two black swan events that had a disastrous impact on the U.S. economy:

  • the 2008 financial crisis and
  • the COVID-19 pandemic,

Both events led to a negative annual growth of the real gross domestic product (GDP) of the United States, writes Thomas Wade is the Director of Financial Services Policy at the American Action Forum. Therefore, the Federal Reserve’s response to these crises was to adopt expansionary monetary policies to stimulate employment and economic growth.

Increasing the money supply — an expansionary monetary policies which intends to increase the amount of money circulating in the economy — tends to increase inflation, states Statista.com, which destabilizes the economy and erodes purchasing power. Currently, the inflation rate in the United States reached 8.5 percent in 2022, the largest value in four decades.

Bottomline is that by expanding its balance sheet—i.e., by buying government bonds and MBS—the Fed expands the nation’s money supply in the hope of lowering interest rates and stimulating the economy; contracting the balance sheet should have the opposite effect.

However, by expanding the money supply too much, the Fed ran the risk of igniting inflation [“Inflation is one form of taxation that can be imposed without legislation.” Milton Friedman], while overly contracting it may stifle economic activity, including increasing unemployment and triggering an economic recession.

Inflation’, quipped Milton Friedman, ‘is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.

Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today.

References:

  1. https://www.statista.com/statistics/1121448/fed-balance-sheet-timeline
  2. https://www.americanactionforum.org/insight/tracker-the-federal-reserves-balance-sheet/#ixzz7esb8x4vu
  3. https://www.fxcm.com/markets/insights/federal-reserve-balance-sheet/

How to Invest in a Recession

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When GDP declines for multiple quarters in a row, it raises concerns over a possible recession.

An unofficial way to measure recessions is two consecutive quarters of negative real gross domestic product (GDP) growth. Real gross domestic product (GDP) is an official inflation-adjusted version of GDP calculated by the Bureau of Economic Analysis.

Annual percent change in real GDP shows how much higher or lower it is relative to the previous year. The higher that real GDP is, the larger absolute increase required to achieve a certain growth rate, and vice versa.

However, according to the Bureau of Economic Analysis (BEA), this is not an official designation of recession. But determining when the economy is in a recession is more complicated than looking at a single data set such as GDP.

Determining when the economy is in a recession is up to a committee of experts at the National Bureau of Economic Research (NBER). The committee officially designates recessions by monitoring a variety of economic indicators, including GDP. It also uses payroll employment, personal income, industrial production, and retail sales in the effort.

The NBER (National Bureau of Economic Research) defines recession:

A recession is 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. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough.

The official designation from NBER of when a recession starts or ends doesn’t happen until months after the recession is over. In other words, NBER looks backward, not at the present moment.

  • Two consecutive negative real GDP quarters is commonly believed to be the definition of a recession. This is a misperception.
  • Despite a negative U.S. GDP growth reading in Q1 and Q2 of calendar year 2022, many of the indicators the NBER monitors when evaluating the state of the economy remain healthy.
  • Coming into 2022, inflation was expected to moderate. Partially due to unforeseen events (including a war), inflation is likely to stick around longer.
  • The Fed has fully achieved the maximum employment half of its mandate, resulting in a sole focus on achieving price stability (cooling inflation).
  • Financial conditions have gone from record easy territory to nearly neutral in a matter of months.
  • Although conditions are not yet restrictive, the Federal Reserve’s dramatic move risks tipping the economy into a recession in the coming quarters.

Historically, there are 12 variables that have foreshadowed a looming recession. A few of those variables include retail sales, wage growth, commodities, ISM new orders, credit spreads and money supply.

During a recession, it’s essential for investors to continue to invest.

What recessions have looked like in the past

The US has gone through 34 recessions since 1857. Thirteen of those recessions occurred after World War II.

From 1857 to 2020, recessions lasted an average of 17 months. In the 20th and 21st centuries, the average length of a recession decreased to 14 months.

Source: Bureau of Economic Analysis (BEA)

The longest recession lasted 65 months, from October 1873 to March 1879. The shortest recession was the most recent, lasting two months from February 2020 to April 2020.

Investing during a recession

You, as an investor, should have an investing process and, and once decided, stick with it to improve your returns.

References:

  1. https://cf-store.widencdn.net/franklintempletonprod/6/7/8/678d815d-fe9c-48b4-9dde-056a19f9653f.pdf
  2. https://usafacts.org/data/topics/economy/economic-indicators/gdp/annual-change-real-gdp/
  3. https://usafacts.org/articles/what-is-a-recession-what-have-recessions-looked-like-in-the-past/

Inflation and Political Silly Season

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40-year record high inflation of 9.1% is driving up the price of everything from gas to groceries, according to a recent Bureau of Labor Statistics report.

The consumer price index was unchanged in July, the first month without an increase since May 2020. But, this does not suggest that the inflation problem has gone away, despite political wishful thinking, states Brian Wesbury, Chief Economist, First Trust.

Energy prices surged 7.5% in June and then dropped 4.6% in July. That’s what you really need to know about inflation in the past two months. As a result, overall consumer prices soared 1.3% in June and then were unchanged in July. But a new inflation trend this doesn’t make. Looking at both June and July, combined, consumer prices rose at an annualized 8.1% rate. That is no different at all than the 8.1% annualized increase in April and May, before the extra surge in energy prices in June then the drop in July.

Some 96% of global economists said they expect the U.S. to face “high” or “very high” levels of inflation for the rest of the calendar year, according to a World Economic Forum (WEF) report. Inflation refers to when prices for consumers increase, thus driving down the purchasing power of consumers’ money.

If you look at the unchanged CPI in July and think the Federal Reserve is nearly done, you’re in for a big surprise, says Wesbury. The Fed isn’t close to done. Yes, the inflation rate likely peaked at 9.1% in June. But getting from 9.1% down to the 5 – 6% range by sometime next year is the relatively easy part. Getting from there back down near the Fed’s 2.0% target is the hard part. Rents have been increasing rapidly around the country and we don’t see that ending anytime soon, which will make it very tough for the Fed to reach its stated goal.

And, it’s delusional to think that the officially-called “Inflation Reduction Act” is actually going to reduce inflation. Inflation is a monetary phenomenon; the bill passed by the Democrat controlled Congress isn’t going to have any noticeable short-term impact on inflation.

Bottomline, regardless of political affiliations, the economy continues to grow and inflation remains a very serious problem. “Investors need to set aside their personal political preferences and follow economic reports as they are, not as they want them to be,” writes Wesbury.

  1. https://www.ftportfolios.com/Commentary/EconomicResearch/2022/8/15/silly-season