There’s been more than a few news headlines recently claiming that we’re on the verge of an economic recession. For many business owners and investors the word recession is a lot like Voldemort. It’s so evil and scary that you’re not even supposed to say it. “Recession” evokes fears of falling stock prices, unemployment, and scarcity.
So what exactly is a recession? And should we treat them with the same respect that Harry Potter treats Lord Voldemort?
Recessions are technically two or more consecutive quarters where national gross domestic product contracts. Gross domestic product (GDP) is sum of all the goods and services a country produces. It’s the broadest and most common way to measure economic activity and the strength of the economy. Growing GDP is a good sign, falling GDP is a bad sign. This is what US GDP growth has looked like since 1930. Lots of major swings between 1930 and 1950, and relatively steady since about 1985. Note that by that time the US dollar was the world’s reserve currency, we were off the gold standard, and interest rates had started to stabilize after stagflation in the 1970s.
Now on to why you should care. The more goods and services a country produces, the better off its citizens are financially. There’s more wealth being created, more jobs available, and usually faster rising wages. For businesses this means that your customers have more stable employment and more discretionary income to buy your products.
In a recession GDP contracts. There’s less economic activity. From a business’s perspective your customers have fewer jobs, lower wages, and less discretionary income. Revenue dries up, and you may be forced to lay employees off yourself. Times are tough.
From an investor’s perspective, recessions are tough on asset prices. The value of your stock holdings, including index funds, depends on the market’s expectation of future cash flows & profitability. Recessions are tough on cash flow, tough on profitability, and tough on stock prices. Recessions often coincide with bear markets.
So where are we now? Are we actually nearing a recession, or is the rhetoric we’re hearing on the news just propaganda? I’m no economist, but I do have some background and stay informed as part of my day job. Here’s my take on whether we’re nearing a recession.