What a perfect topic to start Kulwicki Insights!
R-E-C-E-S-S-I-O-N
A recession is a word used to indicate an economic slowdown. That’s it. A definition often used for a recession is two consecutive quarters of negative real GDP growth. This technical definition of a recession is a backward looking definition. It looks back the last two calendar quarters, what has happened in the past. The term recession does not indicate where the economy is at that particular moment (today) or forecasts where it is going in the future.
The term recession can’t be feared in and of itself. The term recession does not define the magnitude of the recession. That means, if the U.S. economy’s real GDP declines 0.01% in Q1 and declines again 0.005% in Q2, the U.S. is defined to have been in a recession. The term recession itself does not mean an economy is falling off a cliff and we’ve entered a depression. Do Not worry about the term recession. Instead, consider the actual potential change in the economy. A technical recession with very little decline in GDP is very different than a recession with a significant decline in GDP. Again, don’t worry about the term recession, worry about the depth and length of the recession.
Last year, in 2021, the U.S. real GDP grew over 10%. Most economies do not grow 10% each and every year and some slowdown or giveback should be expected. Recessions often occur after periods of excess (consumer/business spending, monetary/government stimulus, speculative market bubbles, etc.) or in periods of significant shock (COVID shutdown). In periods of excess, its tough to add more excess onto even more excess. The economy is tapped out and needs to take a breather. Then, after a period of rest, and excesses are withdrawn, the economy can get on better footing and move forward, eventually hitting another period of excess. This is the economic cycle.
The only thing to fear is fear itself. We’ve all heard that before. Recessions can also be a self-fulfilling prophecy. If enough consumers and businesses become increasingly concerned with a recession that “everyone is talking about”, consumers and businesses would start to reduce spending to protect themselves from a potential recession. Business leaders, investors, consumers are all humans and have emotions and make emotional decisions. Investors need to understand that although there may not be structural issues with the economy that should significantly shift an economy into a severe recession, the fear of a recession itself can be a self-fulfilling prophecy to tilt the economy into a shallow recession. In a shallow recession, excesses can be withdrawn, froth can come out of the markets, and set up for a recovery thereafter.
Investment Implications
Financial markets attempt to price in the future. Looking at the equity, bond, commodity and currency markets the last few months, you can get a sense whether or not markets are attempting to price in an economic slowdown. When risk assets are down over 20%, you can have some indication that markets are trying to price in economic concerns. This market movement is before any economic data has shown to be in any technical recession. With that being the case, the financial markets will start to price in a recovery before the economic data confirms it. as a forward-looking indicator, investors always need to be aware that the markets may not accurately reflect the current economic environment, but rather the future potential economic environment and for that, investors should be positioned accordingly.
Recessions do not always impact all consumers, businesses, sectors, industries, etc. the same. Most consumers and businesses will continue to earn income, even in a recession. Look around. Are you still generating an income? Are you still buying things (toilet paper anyone?)? The world does not stop moving in a recession. Consumers and businesses still need things, they just may be slightly less willing to pay up for things or hold off some things they want not need.
Although the economy doesn’t generally crash in a recession, some consumers and businesses may have reduced income, lose all income, and/or go bankrupt. It can be a tough time for some. Those consumers and businesses that prepare for potential periods of hardship can better withstand tough economic times. This is an important concept when investing. Consider high quality companies that have solid long-term demand for their goods and/or services, and the companies have strong management teams that can navigate through to the other side of a recession and subsequent recovery. Would you prefer to sell your investments in these companies and try to avoid the short-term downward price movements of their stocks and then perfectly time the bottom in the stock price? Or would you be excited to add to these companies that are now trading at a discount to where they were 6-9 months ago? I know what I would do.
When you look at the current economic environment, and look at sentiment (how you and investors feel), do you think we are in a period of significant excess (“I’m making so much money now”) or fear (“oh no a recession”; “oh no my investments are down”). Long-term investors often prepare for these potential recessionary environments and make appropriate investment decisions. Just like in periods where the taxi driver is talking about the newest can’t lose investment that “everyone is making money on” can be signs of excess and froth, periods where the taxi driver is talking about the tough recession and losses on their investments can be signs of potential opportunities to take advantage of.
Investors need to determine whether we are in a period of froth or fear, and make an investment decision based on that belief. Is this the time to reduce risk in a fear-based market? Should you sell an investment that just declined 10%, 20%, 50%+? Or is this a time to add risk, when everyone else is fearful? Are your investments higher or lower than what they were 6-9 months ago? Is this the time to buy low or sell low? How did you feel when your investments may have been higher 6-9 months ago than they are now? Did you feel confident and bought more investments when you felt better? Did you buy or sell at the higher levels?
When the “R-Word” becomes the word of the day, understanding what to do from an investment standpoint is key. If you are a short-term trader or a long-term investor, understanding this dynamic will help you with your investments. What you do today will impact your returns going forward, so make sure your decision is based on logic, not emotions.