Recession: What could cause it, and when?

A popular definition states that two consecutive quarters of negative GDP is one sign that the U.S. may be in a recession. However, the traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months.  A little more nuanced.

Who makes the call? The NBER does.

The National Bureau of Economic Research (NBER), founded in 1929, is a private, nonpartisan organization that analyzes major economic issues affecting the US economy.  Beyond publishing nearly 1,200 working papers and convening more than 120 scholarly conferences each year, it is also the recognized authority for determining US business cycles (i.e., peaks and troughs), and economic expansions and recessions.

Source: Unemployment data is from the Federal Reserve Bank of St. Louis

The above chronology identifies the dates of peak and trough months in economic activity. The peak is the month in which a variety of economic indicators reach their highest level, followed by a significant decline in economic activity. Similarly, a month is designated as a trough when economic activity reaches a low point and begins to rise again for a sustained period.  The committee's view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another.   I will stop there.  We really start down a rabbit hole once we start backing into how each factor is weighted and what conclusions are drawn for all the info.

Essentially, many people can (and do) call for a recession, although that group is typically confined to academic economists and Wall Street strategists. But any mystery enshrouding the arrival of a recession merely lies in the NBER’s assessment of those three factors.  It really is as simple as that and there is no room for conjecture unless you are a real wonk.

A couple of quick observations:

• There has only been one depression: the big one in 1929.
• Since abandoning Bretton Woods in 1976, which ushered in the recent era of modern finance, recessions have gotten both shorter and more infrequent.
  • In fact, the most recent example—from February to April of 2020—was the shortest recession on record.
• Curiously, the last 4 were exogenous shocks, in reverse order:
  • Covid-19 pandemic which gripped the entire world, delivered a supply-chain snarl and subsequent liquidity injection, which the Fed is still dealing with.
  • The Great Recession was triggered in part by the bursting of the subprime mortgage bubble, as well as complex securities created with those bad mortgages that permeated the financial system.
  • The Dot-com bubble came about as massive amounts of money flows into ever-less viable dot-com investments.  Nasdaq ended up losing nearly 77% of its value in a short period.
  • Gulf War.  This may be the weakest of the 4, given that it came a few years after the savings and loan (S&L) crisis, which may have exacerbated the effects of the war.

Since the last recession was recorded in 2020, we are in an ongoing 38-month expansion period.  Though we know this will come to an end. Forecasting the timing will be extremely difficult.  Based on the past, we can hazard a guess what it will look like.

1. Short.
2. The cause will be an external shock very few will have identified.
3. The NBER will ultimately make the call for posterity.

Thankfully, the Fed has managed to engineer a substantial rate hike – giving it a lot of firepower to dig the economy out of a hole when and should a recession happen.  Also, any ding to the economy will come at a time where unemployment is at a near all-time low, which will hopefully mitigate the magnitude of the impact on households, potentially aiding any snapback after-the-fact.

Exogenous shocks or black swan events – by their very nature – are difficult to identify.  But if we make the analogy that they are embers or sparks, where could we identify some potential kindling? As of now, large headwinds include:

• China’s lackluster growth after exiting lockdowns.  It goes without saying that China is a huge portion of global economic growth.
• Russian political intrigue after Wagner flexed on Putin.  A nuclear power showing instability in its upper echelons of government is very worrisome.
• Fed interest rates ‘higher for longer’ could impact a whole slew of industries and sectors, not least of which is the already-maligned commercial real estate sector which has yet to recover from the work-from-home trend.
• AI. This is the only black swan of the litter.  The media is focused on AI’s strengths as an investment theme.  Many futurists and technologists are warning about the effects of AI on employment, cybersecurity and weaponization of social media.