We as humans tend to worry most about the things we can’t control or don’t fully understand. Often times we listen to the news for information, but rather than educating us, it inaccurately reinforces our concerns.
In the financial world, one of the most worrying terms we hear is the word “recession!” but understanding what a recession is and how it’s caused can help you become a more educated investor – and better informed so that you don’t freak out when you start hearing this word repeated incessantly on the TV and radio.
So, what is a recession?
Most would say that we’ve entered into a recession after two consecutive quarters of economic decline, which is measured by our country’s Gross Domestic Product (GDP) along with other economic indicators (such as the employment rate).
The National Bureau of Economic Research is a committee of experts who determine the peak and trough of the business cycle, which ultimately determines whether we’re in the midst of a recession. If you look back at macroeconomic trends since the Industrial Revolution, the long-term economic trend for most countries has been positive. Of course, we’ve seen fluctuations along the way, specifically when certain economic indicators slow down or even reverse course over different timeframes. These periods of decline are what we call “recessions.”
If you observe where we are from an economical perspective today, as of July 2019, we are currently in the longest economic expansion in US history! An expansion starts at its lowest point as measured from the last recession and is measured up to the peak of the economic cycle prior to the next recession. As you can see below, we are 121 months into the current economic expansion (from June of 2009-July 2019).
These times of expansion and recession are all part of the business cycle. The recessionary periods aren’t any fun, but they’re “normal.”
Why does our economy experience recessions?
On the surface, there are many economic theories that attempt to answer this question. Typically, these theories drill down into economic, financial, and even psychological issues.
Some theories explain recessions as solely dependent on financial factors, since often times they’re characterized by slew of business and bank failures, contraction of money and credit offered by these institutions, and decisions made by the Federal Reserve Board. Negative growth in production and elevated unemployment rates are going to be red flags as well, but these causes have indicators we can pay attention to.
Then, there are leading indicators and lagging indicators.
Leading indicators include the ISM Purchasing Managers Index, the Conference Board Leading Economic Index, and the OECD Composite. Some would argue the stock market is a leading indicator of recessions as well (more to come on this in Part 2).
Keeping all this in mind, we have to discuss lagging indicators as well, which tend to confirm an economy’s shift into recession after it’s already begun. Examples of these past-tense indications of recessions include the unemployment rate, GDP, the consumer price index (CPI), and the balance of trade we experience with other countries.
Regardless of the reason, make sure you’re paying attention to the right information, rather than the shiniest headline.
Now that we have a high-level understand of what a recession is, why does this matter to you as an investor and hopeful retiree? Stay tuned for part two of this article and learn how the market comes into play with recessions.Categories: Educational Articles, Market Commentary, Zak Leedom