Economic recessions, while widely dreaded, are about as commonplace as hairline recessions (also widely dreaded). However, unlike receding hairlines, receding economies eventually return to growth. Loosely defined as a significant decrease in economic activity that lasts for more than six months, recessions are simply a normal part of the business cycle.
Recently, SEI Private Trust Company published a Research Commentary entitled, “What is a Recession,” which we thought would be of interest.
Commentary in brief:
- A recession is loosely defined as a significant decrease in economic activity that lasts for more than six months.
- Recessions occur during the contraction phase of the business cycle and are usually caused by higher-than-necessary inflation.
- Bear markets (or declines of 20% or more in a broad stock market index such as the S&P 500 Index) typically accompany recessions.
According to the National Bureau of Economic Research, a recession officially begins after two consecutive quarters of negative real (inflation-adjusted) gross domestic product (GDP) readings—which measure the value of all finished goods and services produced in a country.
However, many experts also say that recessions can start under the radar, between quarterly GDP reports. In order to determine whether the economy is headed for or already in a recession, economists look to two types of data: leading and lagging indicators.
Leading indicators represent areas of the economy that typically change course, with either accelerating or decelerating growth, before the majority of the economy begins to follow. These indicators are thought to foreshadow significant impending changes in the economy. Examples of leading indicators include the U.S. Department of Labor’s jobless claims report, the Conference Board’s consumer confidence index and the Institute for Supply Management’s purchasing managers’ index.
Lagging indicators are areas of the economy that tend to change course only after the majority of the economy has started moving in a particular direction. Examples of lagging indicators include the Federal Reserve’s benchmark interest rate, the U.S. Department of Labor’s consumer price index, and the U.S. Department of Commerce Bureau of Economic Analysis’ gross domestic product and trade-balance data.
When and Why Do Recessions Happen?
In the U.S., a full business cycle runs for an average of 4.7 years and consists of four distinct phases: expansion, peak, contraction and trough. Recessions occur during the contraction phase of the business cycle. There have been 14 recessions in the U.S. economy since 1929 (Exhibit 1). The average recession lasts for about 18 months—as 2007’s Great Recession, the most recent one at the time of this writing, did.
U.S. Recessions Since 1929
Most economists believe that higher-than-necessary inflation is the primary cause of recession. As inflation rises, consumers generally reduce their spending in favor of saving money. A downshift in consumer spending, which drives over two-thirds of the economy, can have a ripple effect on businesses. When consumer demand dwindles, industrial production follows suit, leading to layoffs. Income falls, unemployment spikes and the economy enters a contraction phase.
In addition, unexpected shocks, such as banking crises or a significant jump in oil prices, may send the economy into a recession. The deflation of an economic bubble, which is caused by a rapid escalation of asset prices followed by a contraction, may also lead to a recession.
Our Point of View
Recessions are a painful, but normal, part of the business cycle. Bear markets, declines of at least 20% in a broad stock market index such as the S&P 500 Index, typically accompany recessions (but not all bear markets are accompanied by recessions). In general, selling out of stocks when a recession begins runs counter to one of the basic premises of investing, which is to buy low and sell high. Many investors who pulled out of stocks during the Great Recession regretted it later—not just because of the loss they incurred by selling at lower prices, but also because many missed out on the rebound once the market began to recover.
Remember, bear markets become bull markets and pessimism becomes optimism.
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All the best,
About SEI Private Trust Company
Now in its 50th year of business, SEI (NASDAQ:SEIC) is a leading global provider of investment processing, investment management, and investment operations solutions that help corporations, financial institutions, financial advisors, and ultra-high-net-worth families create and manage wealth. As of September 30, 2018, through its subsidiaries and partnerships in which the company has a significant interest, SEI manages, advises or administers $920 billion in hedge, private equity, mutual fund and pooled or separately managed assets, including $339 billion in assets under management and $576 billion in client assets under administration