The last two years have put the Federal Reserve in the limelight. It is of little surprise after a multi-decade high unemployment level in the second quarter of 2020, followed by concerns of weak spending – which was abated with direct cash transfers, and that turned into a growing concern of increased inflation. The economy began to slow down this year, confirmed by the first negative Gross Domestic Product (GDP) for the first quarter of 2022. But the first negative readout didn’t mean much because, for the most part, GDP reports are sleepy reports subject to revisions. GDP reports are typically referenced in talks about how “hot” the economy is. Yet, most large investors will not bat an eye at GDP reports because they usually know ahead of a print if productivity increases or declines. They are mostly looked at to confirm what we already know. We have now had two consecutive GDP declines which is the big focus at the time.

Most headlines regarding a recession are directly talking about GDP, and they will go on to comment that two consecutive GDP readings mean we are in a recession. But what exactly is a recession? In the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) is generally seen as the authority for dating US recessions. They define a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months.” What does that mean?

Some countries define an economic downturn as two consecutive quarters of negative growth for Gross Domestic Product but not in America. The US looks to academics at the National Bureau of Economic Research who believe that the two-quarter benchmark is overly simplistic for such a complex economy. The nonpartisan panel was established in 1978 by former Ronald Reagan adviser and NBER president Martin Feldstein. And it typically takes the panel about a year to decide on a recession call, though some decisions have been made in a few months while others have taken almost twice as long. That’s almost always well after a recession has been widely recognized by Wall Street.

What we know is that there is no exact formula for a recession. The NBER uses various economic indicators from several categories. Aside from GDP, NBER also looks at its sister statistic, gross domestic income (GDI), which measures the same thing — economic growth — from a different angle: how much money was earned by making all the goods and providing those services we love. While GDP has tapered slightly in the last two quarters, GDI has still risen (Image 1). Strong employment and incomes are a big reason Americans have continued spending. NBER is likely to discount recent GDP numbers (relative to GDI) because GDP was only negative due to a surge in imports.

It is interesting to note that even if there are two consecutive negative GDP prints, it isn’t guaranteed that the NBER will recognize a recession in 2022. For example, take 1947, which saw two consecutive negative GDP prints, but the NBER did not declare an official recession. What is important to note here is that in every business cycle downturn, equity markets lead the economy by several months, if not longer. JPMorgan Chase CEO Jamie Dimon comments that equity markets anticipate the kind of economic hurricanes that CEOs like him expect. In each one, equity markets declined, the economic hurricane worsened a few months later and equity markets bottomed while the economy was still getting worse. So, it is easy to see why some investors may say they know we are in a recession ahead of the NBER actually declaring it.

– Jose Rendon
Senior Portfolio Administrator