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Anyone hoping the U.S. economy would finally return to normal in 2022 following two years of dislocation from the Covid-19 pandemic has been sorely disappointed.
Supply chain disruptions, a war in Ukraine, elevated inflation, and higher interest rates are raising concerns that the U.S. economy is on the brink of a recession.
TD Securities recently said there is more than a 50% chance of a U.S. recession within the next 18 months. Several reliable economic indicators are flashing warning signs that the U.S. economy could be rolling over.
Fortunately, the U.S. labor market remains strong, and experts are divided on whether or not a recession is inevitable in this unique economic environment. This is why Fed Chair Jerome Powell recently said that he didn’t believe the U.S. was in a recession.
Just because the risk of a recession is rising, economists caution there’s no reason for the average American to panic. Recessions have been a relatively common occurrence over the past century and have produced attractive opportunities for long-term investors.
What Is A Recession?
There is no universal definition for an economic recession, but analysts and investors commonly define it as two consecutive quarters of negative gross domestic product (GDP).
By that metric, we are already in one. The U.S. GDP contracted at a seasonally-adjusted annual rate of 0.9% in the second quarter of 2022, after dropping by 1.6% in the first quarter of 2022.
This is why you’ll hear many pundits, especially in an election year, argue that a recession has commenced.
But, the National Bureau of Economic Research (NBER) is officially tasked with identifying U.S. recessions, and its definition of a recession is somewhat vague. The NBER says a recession is “a significant decline in economic activity that is spread across the economy and that lasts more than a few months.”
For instance, the Covid Recession lasted just two months, well below the two-quarter marker.
Jeffrey Roach, chief economist for LPL Financial, says the keyword in the NBER’s recession definition so far in 2022 may be “significant.”
“A slowdown has to be significant, broad and sustained before it qualifies as a recession,” Roach says. “Currently, the economy is downshifting to a much slower growth path, but the decline in economic activity is not ‘significant’ in our view.”
Roach points out U.S. companies are still hiring and consumers are still spending. The U.S. economy added 372,000 jobs in June, far exceeding economist estimates of 250,000 new jobs. That type of job growth doesn’t typically coincide with a U.S. recession.
In addition, analysts still expect S&P 500 companies to report 4.3% earnings growth and 10.1% revenue growth in the second quarter.
If the NBER ever decides to confirm conventional wisdom that the economy is in a recession, and when they would decide to do so, is anyone’s guess.
Everyday Americans, of course, care little for such technicalities when prices are rising so quickly and financial markets are struggling.
Why Are Americans Worried About A Recession?
After years of lockdowns and restrictions, many observers hoped pent-up demand would generate a post-pandemic economic boom in 2022. Instead, Americans are worrying about inflation and recession. What happened?
Inflation and Supply Chain Disruptions
Supply chain disruptions in Asia and economic sanctions against Russian oil and gas have exacerbated the U.S. inflation problem that began in 2021. The Federal Reserve also underestimated how aggressively it would need to act to bring inflation under control.
The BEA recently reported the Personal Consumption Expenditures (PCE) price index rose 6.3% year over year in May. Core PCE—the Fed’s preferred measure of U.S. inflation—was up 4.7% from a year ago.
While core PCE growth is down slightly from peak levels of 5.3% in February, it remains near multidecade highs last seen in the 1980s.
Consumers are feeling the brunt of increased costs for everyday goods and services. The Bureau of Labor Statistics reported on July 13 that the consumer price index (CPI), a measure of the cost of living, soared by 9.1% from last year. The fast rise in CPI is another inflation warning not seen in four decades.
Fed Interest Rate Hikes
In response to alarming inflation, the Fed has raised the federal funds rate substantially this year, including back-to-back 75 bps hikes after meetings in June and July.
“[The] second consecutive 0.75 basis point Fed funds rate hike makes this move the most aggressive since the FOMC began announcing Fed funds actions in 1990,” says CFRA chief investment strategist Sam Stovall.
At the time of this writing, the bond market is currently pricing in a 74% chance of a 50 bps rate hike and a 26% chance of a 75 bps rate hike in September, according to CME Group’s FedWatch tool.
The higher interest rates rise, the more expensive it becomes for U.S. companies to borrow money to invest in innovation and growth. Rising credit card, mortgage, auto loan and other interest rates also reduce the disposable income Americans have to spend in the economy, weighing on corporate earnings and stock prices.
Of course, that’s the point: The Fed wants to quash inflation by slowing down the economy. They hope they’re able to do so without causing too much damage.
Yield Curve Inversion
Concerns about a U.S. recession ramped up in early July when the yield on 2-year U.S. Treasury notes jumped above the yields on 10-year Treasury notes, a phenomenon known as a yield curve inversion.
Inverted yield curves have historically been a strong economic recession indicator. Two-thirds of the time, the U.S. economy has historically fallen into a recession within 18 months of a yield curve inversion.
The current yield curve inversion is the deepest since 2007, the year before the notorious global financial crisis.
The Case Against Recession
Despite market fears and warning signs, many economists say the economy is simply too healthy at the moment to consider current conditions a recession.
Peter Essele, head of portfolio management for Commonwealth Financial Network, says the latest U.S. jobs report should reassure investors.
“Year-over-year job growth stands at 4.31%, the largest gain in almost 40 years. It’s difficult to rectify how some are claiming the economy is in recession when job growth remains well above long-term averages and wage growth is the strongest in decades,” Essele says.
Quincy Krosby, chief equity strategist for LPL Financial, says the solid U.S. labor market suggests a U.S. recession is not imminent. However, if recession fears trigger a shift in consumer behavior.
“Because of the market’s intense focus on whether we’re currently in a recession or heading into one, the oft-told comment by economists that it’s important to watch what consumers do that counts and not what they say has become increasingly important,” Krosby says.
He says U.S. consumers account for nearly 70% of the overall economy, and consumers are getting squeezed by higher gas prices, interest rates, and grocery bills. In June, the University of Michigan’s Surveys of Consumers consumer sentiment index fell to its lowest level dating back to the mid-1970s.
“Retail sales reports, coupled with what consumer-related companies tell us about their customers’ spending behavior, should provide some of the most important signals as to where the economy is headed,” Krosby said.
Second-quarter earnings season and management commentary from major consumer discretionary companies, such as Amazon (AMZN), Tesla (TSLA) and Home Depot (HD), could be particularly telling for investors who are on recession watch.
Should You Be Worried About a Recession?
If the U.S. does slip into a recession sometime this year or in 2023, there’s no reason for investors to panic.
First off, recessions don’t historically last very long. The average duration of a U.S. recession since World War II is just 11.1 months, and the Covid-19 recession in early 2020 lasted just two months.
U.S. recessions are also fairly common. Since World War II, there has been about one U.S. recession roughly every five years.
While recessions can lead to job losses and other financial difficulties for Americans, they have historically been excellent buying opportunities for long-term investors. It can be extremely difficult for investors to time a market bottom perfectly, and stocks tend to bottom several months before a recession when peak pessimism is reached.
But some stocks even have a track record of performing relatively well during recessions. For example, Target (TGT), Walmart (WMT) and Home Depot shares significantly outperformed the S&P 500 during the 2020 and 2008 recessions.