Let's Talk About Recessions

As many of you are doing right now, I am spending the final weeks of 2023 planning and organizing my business strategy for 2024. This process includes research of market analysis, reading through articles and opinions, and talking to business professionals across the country.

One theme continues to surface.

RECESSION!

Is one coming, did we achieve the "soft landing", is it already here, or is it still a few years out? It really is impossible to predict the future of markets and economies, and I don't intend on doing this here. However, I do want to shed some light on Recessions: What are they, who determines when we are in one, and what do the statistics and leading indicators say about when the next one should occur?

So, What Even Is A Recession?

Sometimes, the easiest answer is the best. Basically, a recession is a period of time where we see contraction, not expansion, of our economy. Another easy answer to understand, but not the official answer, is that a recession is 2 or more fiscal quarters where we see a decline in Real GDP.

This used to be the most common definition, but even that became confusing back in 2022. Reference the chart below, I’m sure we all remember when we had 2 consecutive quarters of negative GDP growth, yet no recession was declared.

So was that a recession? Not according to the NBER.

The trusted authority on recession determination is the National Bureau of Economic Research (NBER). This is a private, non-profit, non-partisan research organization?that has been determining periods of economic expansion and contraction since the earls 1900s. This group is the authority, and they give a little deeper of an answer to this original questions. They describe a recession as a significant decline in economic activity spread across the entire economy, lasting more than a few months, normally visible through decreased Real GDP, Real Income, Employment Percentages, Industrial Production, and Wholesale/Retail sales.?

Ok, Then How Do They Determine We Are In?A Recession?

The NBER publishes reports detailing if the economy is in a state of expansion, or recession, and they usually backdate the start points once enough data is collected. This means that Recessions are usually declared after they have been happening for up to 6 months (2 Quarters). This gap allows for short-term fluctuations to not affect the overall pulse of the US economy.

However, it is also in this gap that all the "experts" come out with their proclamations. For example, you can do a simple Google search now to see recession predictions that were placed 1-2 years ago. Clearly, these have all proven to be false, up to now, but eventually they will come true (don't worry, recessions are common and natural).

The exact number is debatable, given some poor data from the start of our Country, but many experts say we have had as many as 48 recessions since our national economy started. Just do some basic math, and you'll see that on average, we experience a recession every 5 years.

What about the numbers?

Now that we have a decent understanding of what the NBER is evaluating, let's look at some charts.

These three charts show some of the data that is evaluated by the NBER. Let’s look back at those two quarters in 2022, zoomed in below:

As you can see here, the NBER determination from this period begins to make more sense. While some factors were indicating a recession, other factors were not. For example, unemployment was still trending down form the pandemic highs, and decreased overall throughout 2022.

One key to remember though, is that all of this data is “rear-facing”, meaning that it is basically impossible to use this data to try and forecast or predict when the next recession will occur.

However, there are some unofficial "forward-facing" or "leading" indicators that many people pay attention to.

Recession Indicators?

Below are some charts that many use to try and predict the next recession.

First up is the yield curve tracker. This chart shows the relationship between the 10-year treasury bond and the 1-year treasury bond. Typically, longer bonds are considered to be "more risky" when compared to shorter bonds. This increase in risk results in a higher yield expected form the potential buyer. Graphed out, these yields from each bond group typically show a uniformed curve starting with lower yields for shorter term bonds and rising towards higher yields for longer dated bonds. However, the yield curve can also invert, meaning that the chart starts out higher with the shorter term bonds, then trends down as you move towards longer term bonds. When the yield curve is inverted, it is showing that buyers are demanding higher yields for short term bonds, compared to ones with longer terms. Reference the chart below, this shows examples of the yield curve as normal (blue), flat (black), and inverted (green). The chart above is just showing the difference between the 1 and 10-year bond, over time. As you can see, the yield curve has been inverted for all of 2023.

Next is the US Institue of Supply Management Manufacturing New Orders Index. This chart represents survey data collected from over 400 executives from the US industrial sector each month. The survey collects data along five seasonally adjusted components used in the final calculation:

1. New orders
2. Employment
3. Production
4. Supplier deliveries
5. Inventories.

The survey uses a scale from 0 - 100 for grading each category, with anything above 50 representing and expansion of that category, and anything below 50 is seen as a contraction.

Typically, anytime the chart dips below 43.5 is seen as a leading indicator of an upcoming recession. The chart has dipped below this number twice this year, first in January (42.5) and then in May (42.6). November came in at 48.3.

Lastly is the Conference Board Leading Economic Index (LEI).The LEI is comprised of 10 unique inputs which the Conference Board says is designed to "anticipate turning points in the business cycle by around seven months." The 10 inputs are:

1. Average weekly hours in manufacturing
2. Average weekly initial claims for unemployment
3. Manufactures new orders for consumer goods and materials
4. ISM index of New Orders
5. Manufactures' new orders for nondefense capital goods excluding aircraft orders
6. Building permits for new private housing
7. S&P 500 Index of Stock Prices
8. Leading Credit Index
9. Interest rate spread (10-year treasury bonds less the federal funds rate)
10. Average consumer expectations for business conditions.

The LEI chart shows a six-month annualized growth rate, and historically has predicted a recession when this number drops below -4.0%. As you can see from the chart above, it has been below this threshold for most of 2023.

Charting The Way Forward.

Like I said before, I'm not in the business of predicting?economic fluctuations and trends. However, it is critical that I?have a good understanding of these trends and know?how they could affect my clients.

I encourage you to do your?own research on this topic, and follow the wise advice of "plan for the worst, hope for the best." When times are good, position yourself, your family, and your business to best perform during the downturns. With the proper guidance, tools, and partners, you can not only survive the next recession, but you could even see continued growth.