If a friend were to ask you what the definition of a recession is and are we in one, how would you respond? There are multiple answers. For example, we have heard a recession defined as two negative Gross Domestic Product (GDP) quarters in a row, or a large stock market decline, or increasing unemployment, etc. It could be argued that all of these portend or are the result of recession, but the truth is that only one governing body has authority to proclaim whether we are in a recession: The National Bureau of Economic Research (NBER). Officially, the NBER defines recession as, ‘a significant decline in economic activity that is spread across the economy and lasts more than a few months.”1 This article isn’t going to provide an opinion regarding a potential recession, but rather create context around the subject, both from an economic and market perspective. With that said, let’s expand on the topic of recessions.
Admittedly, the definition of recession is rather vague, but one could argue that it isn’t overly negative and doesn’t have to create a dire scenario. Sure, there is mention of protracted weakness in economic activity, but notice the NBER uses the word ‘months’ and not years. If the official definition of recession doesn’t necessitate a doomsday scenario, then why do many of us believe a recession is worse than it is? Two reasons: recency bias and availability bias. Recency bias is a cognitive bias that favors recent events over historic ones; i.e. a memory bias2. Availability bias is a mental shortcut that relies on immediate examples that come to a given person’s mind when evaluating a specific topic3. As you’ll see in the next two paragraphs, both of these biases come into play due to extreme recent events.
Since World War II, recessions have become less harsh, lasting an average of 11.1 months4. The longest post-WWII recession was the great recession that began in December 2007 and ended in June 2009, for a total of 18 months, or 64% longer than the average4. The most recent recession was due to COVID-19 in early 2020, and although the recession technically only lasted two months, the velocity at which the unemployment rate rose made it feel a lot longer and worse than the data indicates. To elaborate, in those two months the unemployment rate went from 3.5% in February 2020 to 14.7% in April 2020. The latter is the highest on record dating back to 19485. Given the two most recent recessions, and the aforementioned inherent biases that exist in the majority of human beings, it is extremely understandable that folks expect a recession scenario will follow the pattern of the previous two.
As it relates to the stock market, there is no question that stocks are negatively impacted by recessions. The good news is that they have always recovered and surpassed their pre-recession levels. For example, during the COVID-19 recession the S&P 500 fell 33.92% from its highest point during the recession. The S&P 500 took 126 trading days after the end of the recession to recover to its pre-recession level, and it continued to rise through the early days of 2022. During the great recession, the S&P 500 fell 55.47% from its highest point. The S&P 500 took 895 trading days after the end of the recession to recover to its pre-recession level6. Although the great recession took longer to recover than the COVID-19 recession, the market was still was able to recover in time.
It is undeniable that the last two recessions were painful from both an economic and stock market perspective, but that doesn’t have to be the case. For example, the S&P 500 fell only 19.83% from its highest point during the recession of January through July 1980, and it fell only 21.57% from its highest point during the recession of the early 1990’s6. Both of these peak to trough declines were significantly less than the last two recessions.
To summarize, we won’t predict whether we are currently in a recession or could go into a recession, but rather we believe it makes sense to look at the long-term history of recessions and recognize the associated investor biases. If we do go into a recession, statistics show that it may not be as painful as the last two have been. If you are concerned about the economy or stock market and/or want to discuss in more detail, please give us a call, as we always welcome the opportunity to discuss the markets and how they relate to your personal long-term financial planning.