“Never miss an opportunity like a recession,” Jack Welch, former chairman and CEO of General Electric (NYSE:GE).
In an attempt to combat runaway inflation, the US Federal Reserve, along with other central banks around the world, began increasing interest rates — and if Chairman Jerome Powell gets his way, those increases will continue. But as most economists will tell you, central banks don’t have the best track record for curbing inflation without causing a recession.
“Since the postwar era, the vast majority of federal tightening cycles do end in recession. So this time it should be the base option.” said Chris Wood, head of equity strategy at Jefferies Hong Kong, during his keynote presentation at the recent Gold Forum Americas. Wood expects a recession in the US by mid-2023.
Others believe the country is already in recession, with US gross domestic product (GDP) falling 1.6 percent in the first quarter of 2022, followed by a 0.6 percent contraction in the second quarter. Two consecutive quarters of GDP declines are often considered the most important signal that a recession is underway.
In addition to GDP, another key indicator for the health of the economy is the price of copper. Red metal is the most widely used of base metalsfrom the construction industry and electronics to electric vehicles and charging stations.
Its recent price action does not bode well. Economics of trade reported in early October that “copper fell for a sixth straight month in September and still trades about 30 (percent) below this year’s high as aggressive monetary tightening by major central banks aimed at curbing inflation raised fears of a global economic slowdown that could hurt demand for commodities”.
Despite these and other factors, some don’t even want to say the word “recession.” U CNN interview in mid-OctoberUS President Joe Biden has said that he does not expect a recession in the near term, and if there is one, it will be only a “very small recession”.
So are we in a recession? While the answer is difficult to find, investors can learn what a recession is, how long it lasts, and what strategies can work well during these tough economic times.
What is a recession?
When a country’s economic activity experiences a severe and sustained decline over a long period, often for two consecutive quarters, economists call it a recession. Some of the key indicators of a recession include rising unemployment, negative GDP, a sell-off in stock markets and falling manufacturing data, as well as declining consumer confidence as evidenced by falling retail sales. Recessions affect a wide range of economic sectors, not just the downturn of one or two industries.
Answering the question: “Are we in a recession?” difficult because there are so many factors at play – while one expert may weigh a significant drop in GDP, another may consider other elements more important.
Watch the video below to understand why consensus can be difficult to achieve.
Experts Rick Rule, Adrian Day and Mike Larson explain why it’s hard to get an answer to the question of whether the US is in a recession.
What causes a recession?
Forbes lists a number of catalysts that can trigger a recession: a sudden economic shock, excessive debt (think of the US subprime crisis that triggered the Great Recession in 2008), asset bubbles, runaway inflation (which forces central banks to raise interest rates, making it more expensive to do business or pay debts), rapid deflation and technological change.
How long do recessions last?
Recessions are considered part of the normal expansion and contraction of the business cycle. Although recessions are not as catastrophic as depressions, they can last for months or even years, with significant consequences for governments, companies, workers, and investors. Each of four global recessions since World War II lasted about a year.
However, the US has had several short-lived recessions, including the 2020 pandemic. Stock markets around the world have crashed since the start of the COVID-19 outbreak. Record 20.5 million jobs were lost only in the US in April 2020, when the country’s unemployment rate reached 14.7 percent.
The Fed responded lower interest rates, and the US federal government provided trillions of dollars in financial aid to laid-off workers and affected businesses. By October 2020, US GDP had increased by 33.1 percent, marking the end of the recession.
What happens during a recession?
Businesses often tighten their belts during recessions, delaying expansion plans, reducing hours and benefits, or laying off employees. Those same workers are consumers who play an important role in the strength of the country’s economic activity.
With less disposable income, consumers stop spending on major appliances, vehicles, new homes, nights out and vacations. The focus is shifting to low-cost essentials, food and medical needs. Declining consumer spending and demand for goods and services pushes the economy deeper into recession, leading to more layoffs and higher unemployment. Small and medium-sized business owners may even find themselves unable to operate fully.
As the recession worsens, some homeowners may not be able to make their mortgage payments and may face default, which could lead to further declines in home prices. Those still shopping for a home or a new car may find that banks have introduced much tighter mortgage and auto lending policies. Meanwhile, investors can lose money as their stocks and real estate lose value. Retirement savings accounts linked to the stock market can also suffer.
All of these forces can contribute to a deflationary environment that forces central banks to cut interest rates in an attempt to pull the economy out of recession.
How to prepare for a recession?
There is no perfect answer to how to invest during a recession, and no stock will remain recession-proof. But for those who know how to do their due diligence with fundamental analysis, recessions offer an opportunity to pick up quality stocks at a discount.
“The stock exchange is the only store where, when things go on sale, everyone runs out the door. You don’t want to be one of those people.” Shawn Cruz said, chief trading strategist at TD Ameritrade. “So if you have a long-term focus and some specific names you’re looking at, now is a good time to pick up some quality stocks for your portfolio.”
Better to look at established public companies with strong balance sheets and minimal debt that still have the ability to generate cash and pay dividends. Companies to avoid include those with high debt loads and little cash flow, as they struggle to manage operating costs and debt payments during recessions.
Industry also matters. Typically, retail, manufacturing, restaurants, technologies, travel and entertainment were hit the hardest during the recession. On the other hand, stocks of consumer goods (food and beverages, household goods, alcohol and tobacco) and health care (biotechn and pharmaceutical) sectors tend to perform well in recessions. Once the market recovers, tech stocks seem to benefit the most.
Investors can further reduce the risks that a recession brings by creating a diversified portfolio that considers stocks in different sectors and geographies. Instead of investing in individual stocks, exchange funds with low management fees is another way to spread risk. The Vanguard Consumer Staples ETF (NYSEARCA:VDC) or the Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP) are two examples to consider.
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Securities Disclosure: I, Melissa Pistili, have no direct investment in any company mentioned in this article.