The long history of financial markets, like most classic novels, is full of misunderstandings, miscalculations and mistakes. Despite all of this, the story normally twists and turns its way to a happy ending. This may yet be the case for investors in the very unusual economy that has unfolded following the pandemic recession and recovery.
At his press conference last Wednesday, Federal Reserve Chairman Jay Powell said he didn’t believe the economy was in recession. In support of his opinion, he pointed to labor market strength, including payroll gains averaging 450,000 per month, an unemployment rate near a 50-year low at 3.6% and continued strong wage gains.
The next day, the Bureau of Economic Analysis announced that U.S. real GDP had shrunk for a second consecutive quarter, providing fresh ammunition to those who argue that the economy is in recession.
Technically, we believe the Fed Chairman is correct. However, today’s strong labor market is, in many ways, the result of extraordinary conditions at the end of the pandemic and may fade in the months ahead. If it does, in tandem with cooling inflation, a data-dependent Federal Reserve will likely become less aggressive and this could, even with recession, ultimately establish a better environment for investors.
The Technical Definition Of Recession
Almost since its foundation in 1920, the National Bureau of Economic Research (NBER) has assumed responsibility for defining when a slowdown in economic activity constituted a recession and for establishing the dates of the peaks and troughs of U.S. business cycles. In 1978, the NBER formally created a Business Cycle Dating Committee to make these calls on an ongoing basis.
The Committee’s definition has shifted a little over the years but it has always been broader than just “two consecutive quarters of negative real GDP growth.” Currently, they define a recession as “….a significant decline in economic activity that is spread across the economy and lasts more than a few months.” Determining when the economy enters recession is based on a number of economic indicators including:
1. Real personal income less transfers
2. Non-farm payroll employment
3. Employment as measured by the household survey
4. Real personal consumption expenditures
5. Combined wholesale and retail sales, adjusted for price changes
6. Industrial production
Looking at this list, there are plenty of signs of softness in the economy today. In particular:
• Real personal income less transfers has fallen in three of the last six months and is below its December 2021 level.
• Real personal consumption expenditures have risen so far this year but fell by 0.3% in May and only recovered by 0.1% in June.
• Combined real wholesale and retail sales appear to have declined in four of the last five months.
• While overall industrial production rose slightly in May before falling slightly in June, manufacturing production fell by 0.5% in both months.