Articles

Are We in a Recession?

| By Matthew Snider

The Commerce Department announced gross domestic product (GDP) fell at an annual rate of 1.6 percent in the first quarter. Two consecutive quarters of negative growth is viewed as the common definition of recession. 

In the second quarter, GDP fell at an annual rate of 0.9 percent. This was the second consecutive quarter that we saw the economy contract. So, before I discuss how an official recession is determined and whether or not we are in one, I’d like to take a deeper look at the factors that contributed to a shrinking in the economy for the most recent quarter.  

Consumers and the Economy

Let’s review how GDP is calculated. This is an equation that includes consumer spending or what the U.S. consumer spends on goods and services. It is the largest contributor to GDP at 68 percent. In addition, we have government and business spending at nearly 30 percent, and the last component, net trade, which nets imports and exports.  

As 2022 progresses, we see the challenges that consumers and businesses face. Some examples are high inflation, supply chain disruptions, poor consumer sentiment and rising mortgage rates. All of this has brought about an expectation that a slowing economy was both inevitable and desired by the Federal Reserve to combat the highest inflation we’ve seen in decades.  What does this tell us about the state of the U.S. economy?  

It tells us consumers are the most important contributors to the economy. Consumer spending was up 1 percent. This was a “slowing” from the previous quarter. However, it shows us that even in light of the issues mentioned, consumers are still spending. What is interesting about consumers in the second quarter was what they spent their money on. Consumers spent more money on services like traveling, dining out, and recreation. They cut back on goods, which is an obvious change in spending patterns.  

Second Quarter Data

In the second quarter, exports rose by an annual rate of 18 percent. This is attributed to international travel to the U.S. and demand for goods made in America. This further strengthened the dollar.

The areas that pushed the economy to contract were largely tied to inventories. Consumers favored spending on services, rather than goods last quarter, and left companies with stockpiles of products that they must cut prices on to move off of their shelves. This issue was evident in Walmart’s recent earning announcement.  

We also saw declines in residential investments and government spending, netting out to an economy that shrunk in the second quarter.  

The Outcome

When we look back to the first quarter of 2022, GDP declined 1.6 percent. But the main culprit was the large trade deficit at 7.6 percent, unlike what we saw in the recent quarter. This alone pushed GDP down almost 4 percent. 

Consumer and business spending, both large components of GDP, were up in the first quarter. So when you dig deeper, you see that the headlines made things look worse than they really were.  

While the previous two quarters had positive aspects to them, they both showed an economy that has contracted. Historically, contraction is what most people look to as a definition of a recession. 

When Recession Becomes ‘Official’

The National Bureau of Economic Research, (NBER), is a nonprofit academic group who is responsible for defining recession. They say recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”  

While that’s pretty non-specific, and probably the reason why everyone always points to two consecutive negative quarters for GDP, eight economists that make up the NBER Business Cycle Dating Committee are tasked with making the official proclamation.  

They look at a number of different factors when putting the official “recession” label on the economy. Two important characteristics of a recession are sharp drops in output and employment. That is mainly semantics. 

The data shows an economic contraction. But other typical characteristics of a recession, like business failures and job losses, are not present at this time. In fact, in the second quarter we saw nonfarm payroll growth of 375,000 per month. This is the opposite as what we’d expect in a recession. 

Based on items like these, NBER is unlikely to label the previous two quarters an official recession. However, that’s not to say we’re not heading in that direction, but we would need to see some of the more traditional features of recession develop.  

Gaining Perspective

Finally, history can provide a glimpse of what recession looks like. According to the NBER, there have been 12 recessions since 1948, roughly one recession every six years.  

In addition, the average recession sees GDP shrink by 2.5 percent and last only ten months. By comparison, economic expansions see GDP grow by 24.6 percent and last, on average, close to six years. While recessions are part of the economic cycle, they are only a small part.     

An important takeaway is to not get caught up in the headlines and the noise. Depending on your definition, we may very well be in or headed into a recession. But remember, the stock market is forward-looking. It is trying to anticipate where we’re heading, not where we are. That may be why the S&P 500 was up over 1 percent on Thursday, July 28, when this news was announced. That report was in the past. The markets look to the future.

MASTERPLAN: a healthy financial future requires a plan.

DISCLAIMER: Past performance does not predict future results. This report is based on data obtained from sources we believe to be reliable. Hefren-Tillotson does not, nor any other party, guarantee the accuracy or completeness of this report or make any warranties regarding results obtained from its usage. All opinions and estimates included in this report constitute the firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation to buy or sell the securities herein mentioned.