The “R” word is appearing in news stories more and more and carries with it a sense of dread. Does talk of a recession make you afraid? Should you be afraid? What is a recession? The definition of recession is a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP (Gross Domestic Product) in two successive quarters. Gross domestic product is the total value of goods produced and services provided in a country during one year. Please reread the definition of a recession carefully and note the word “temporary.”
I mentioned in previous blogs the tendency of the financial markets to anticipate the future. I recently received the following from Kiplinger’s A Step Ahead and want to share part of the short article with you (all highlights and quotes are from the original article):
Investors shouldn’t fear recessions; they should fear what comes first. A confluence of factors, including sky-high inflation and a ground war in Europe, have Wall Street analysts beginning to murmur louder about the possibility of a recession. For investors worried about the same, Sam Stovall, chief investment strategist for independent research firm CFRA, has some good news (sort of): Stocks do fairly well during recessions; it’s the lead-up that’ll kill you. “The S&P 500 rose an average 1.8% during all recession periods since 1945,” Stovall says. That’s because “investors anticipate the start and end of recessions, causing the S&P 500 to top out before the start of these recessions and bottom before their conclusion.” By comparison, the S&P 500 has telegraphed recessions by an average of about seven months, declining anywhere between 7% and 57%. So by the time these recessions are officially recognized – a job assigned to the National Bureau of Economic Research, which needs at least six months to identify a recession – investors often are looking at signs that economic recovery is underway. “In all cases but one, the S&P 500 bottomed before the end of recessions by an average of five months.[i]
What is the stock market telling us? For all of April, the Nasdaq dropped 13.3%, its biggest monthly decline since October 2008. The S&P 500 fell 8.8% while the DJIA fell 4.9%, their worst months since March 2020.[ii] Year-to-date 2022 (end of April), the S&P 500 was down over 13%. Should we be concerned? Now it is May, the Fed approved a half point increase in its key lending rate, which was widely anticipated, but cautioned against expectations of larger rate increases. The stock market liked the latter and shot up, only to drop the next trading session.
It might be helpful to put the stock market moves in perspective. Last week I attended a lecture at the local college entitled: Pandemic Economics: A Conversation with Neel Kashkari. Mr. Kashkari is president and chief executive officer of the Federal Reserve Bank of Minneapolis, one of twelve Federal Reserve Banks across our country. They are part of the Federal Reserve System whose purpose is to do the following:
- Conduct the nation’s monetary policy
- Promote the stability of the financial system
- Promote the safety and soundness of individual financial institutions
- Foster payment and settlement system safety and efficiency
- Promote consumer protection and community development.[iii]
The Federal Reserve Banks gather data from their respective districts, bring it to the table and share it at meetings of the Federal Reserve Open Market Committee so that the Committee may make sound monetary policy decisions. Since 1977, the Federal Reserve has operated under a mandate from Congress to “effectively promote the goals of maximum employment, stable prices, and moderate long term interest rates”—what is now commonly referred to as the Fed’s “dual mandate.”[iv] In simpler words, it is the Fed’s job to limit unemployment and control inflation.
The unusual dynamics of the pandemic recovery have complicated the Fed’s goals of maximum employment and stable prices. As worldwide economies shut down, consumers focused on purchasing goods, versus their more normal purchases of both goods and services. We could not venture out of our homes to sit in a restaurant or bar, get a haircut or a massage, go bowling, or many of the hundreds of other services that we take for granted. The focus on goods caused back orders (increased demand) at the same time most manufacturers were either closed or on reduced shifts (decreased supply). To exacerbate that mismatch, there was a delay in shipment of goods, especially internationally. Supply chain issues multiplied. Prices of goods increased (demand was greater than supply).
Wages, on the other hand, did not keep pace. I think many of us would agree with economist Paul Krugman: “all of us tend to feel that we earned our wage increase, but that price increases are something that is done to us, even though it’s actually part of the same process.”[v] If your community is like mine, there are dozens and dozens of help-wanted ads in the paper or online every week. Employers cannot find enough workers to meet the demand, especially for workers in the service industries.
There is a reshuffling of workers to those positions that offer a better lifestyle and/or better pay. According to Kashkari, we need to pay workers in areas where they are needed more, offer retraining programs (best done locally), and put money into early life education. People make decisions based on risk (or benefit) to their family and the pandemic gave us all time to reassess. He also suggested that living and making decisions during the uncertainty of the pandemic taught us all, especially young adults, a valuable skill and emphasized the value of work and the benefit of more and better education.
Ok. That explains why we are seeing inflation in general, but why is inflation in the U.S. higher than our peers? Kashkari explained. It is because U.S. fiscal policy to provide stimulus during the pandemic was more aggressive than other countries. One of the lessons learned from the 2008 financial crisis was that stimulus was not aggressive enough and therefore it took ten years to get jobs back. The desire was to speed up that process.
Supply change issues still complicate the Fed’s goals, however, and Russia’s invasion of Ukraine is another. In fact, those are the Fed’s two biggest concerns according to Kashkari. When asked what he predicts for the future, Kashkari responded: “In the short-term, it depends on the virus and the situation in Ukraine, but in five years we should be back on track.”
I am not sure what our world may look like in five years, but I know it will not be the same as the past and I want the future to be better! How “normal” will be defined is yet to be determined. Meantime, hang in there. The U.S. economy may dip into a recession, but if you have set aside a healthy emergency fund and can cover your living expenses and necessary debt payments with your income, then your long-term investments can weather the downturn. Remember the word “temporary” in the definition of recession.
In the meantime, you can expect higher prices for goods and services. The Fed has told us that they will continue to raise interest rates to try to bring inflation under control and all of us will be affected by that. It may be a bumpy ride. Now is a perfect time to review your budget and adjust it as needed. Tighten the ship.
~Beverly J Bowers, CFP®
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