Outlook for a Recession

February 29, 2016 5:59 pm
Betsey

Betsey A. Purinton, CFP®

Managing Partner & CIO

If one looks at the returns for the S&P 500 from 1980 through 2015, the “down years” (returns of negative 7% or greater at year end) have all been tied to one of three events: a recession, a bubble bursting, or a credit crisis. In this week’s commentary, I talk about the first cause of possible bear markets: recessions.

Pessimists like to throw around the “R” word when markets become volatile. That is easy to understand, since most bear markets (a decline of 20% or more) occur at the same time as a recession. However, not all volatility that approaches or exceeds 20% is caused by a recession. Case in point: August 2011, when markets declined 19% in reaction to the refusal of Congress to lift the debt ceiling. Markets recovered by late October of that year. And in a matter of weeks during October 1987, markets descended 34% with program trading and illiquidity getting most of the blame. Markets gradually recovered by August 1989.

However, recessions do happen fairly often – they are part of the natural economic cycle, and are to be expected. And while they are painful, few are as weighty and vicious as the 2008-2009 Great Recession, which came in concert with a severe credit crisis.

In addition, the severity of a recession depends on the strength of the economy as it reaches the peak of the business cycle. Think of a 10 story office building: if prices, inflation and demand have been riding high and the economy is on the top floor, the recessionary fall can be dramatic. If, on the other hand, the previous recovery has been anemic (as we have witnessed recently), the fall from the first or second floor can be much less painful.

In other words, not all recessions are created equal.

The common definition of an economic recession is two back-to-back negative Gross Domestic Product quarters – that is, two three-month periods of negative growth. But this definition over simplifies the characteristics of a recession. Most economists, policy makers and academics look to the National Bureau of Economic Research, a private non-profit research organization, for guidance on when a recession actually begins and ends. NBER’s definition is more complex:  “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.” http://www.nber.org/cycles.html

Given that definition, the outlook for another US recession in the near term is small. Robust services activity, improving housing and jobs markets, and healthy consumer spending are offsetting the negatives: slow factory activity, weak demand from abroad, too much inventory and widening credit spreads. (Ned Davis Research). Add to that: GDP growth hasn’t been negative two quarters in a row since 2009.

So the US is looking okay. But what about a global recession? After all, most of the fears being reflected in the stock market come from what happens overseas, most notably China and the emerging markets. Here the prediction is more complicated, since there is no one accepted definition of a global recession. In part, that is because global countries, as a whole, hardly ever contract simultaneously (2009 is one notable exception). As a result, common definitions reflect a slowdown in economic growth or overall economic growth of less than 2 or 3% rather than a traditional US recession. When global growth experiences a downturn, the discussion turns to how particular countries or regions impact other countries or regions.

And here is where the US domestic oriented economy shines. We are less dependent on other countries than we often believe. As a result, our economy is somewhat protected from overseas economic turmoil. That does not mean that a slowing global economy will not impact the US, but rather that it is unlikely to cause a recession in the US. This notion is supported by research firm RecessionAlert, which notes that the correlation between global recessions and US recessions is surprisingly low.  (http://recessionalert.com/global-slowdown-does-it-affect-the-u-s/)

At some point there will be another recession, but in our view it is not an immediate concern. From a business cycle standpoint, we are entering the late innings of this recovery game. The last innings are unlikely to be different from the rest of the innings – drawn out and slow. With stocks fairly or fully valued, returns over the next few years could be relatively muted. And that may be the price we have to pay for delaying a serious recession.

 

Betsey A. Purinton, CFP® is Managing Director and Chief Investment Officer at StrategicPoint Investment Advisors in Providence and East Greenwich. You can e-mail her at bpurinton@strategicpoint.com.

The information contained in this post is not intended as investment, tax or legal advice. StrategicPoint Investment Advisors assumes no responsibility for any action or inaction resulting from the contents herein. Betsey’s opinions and comments expressed on this site are her own and may not accurately reflect those of the firm. Third party content does not reflect the view of the firm and is not reviewed for completeness or accuracy. It is provided for ease of reference.