All Recessions Are Not Created Equal
Over the past few weeks, more and more economists are suggesting that a recession is coming. And as the cadence of recession chatter increases, Americans are beginning to question how it could affect our day-to-day lives and, more specifically, what it means for our wallets.
But instead of allowing our Chicken Little tendencies to prematurely conclude, “The sky is falling,” let’s take some time to consider where we’ve been, where we are now, and where we’re likely heading.
Let’s start with the basics. At minimum, a recession is marked by two consecutive quarters of negative gross domestic product (GDP), but it’s usually accompanied by other downturns in economic activity as well, such as employment, production, or sales.
As a result, all recessions are not created equal. Depending on how significant the economic declines are, a recession could be characterized anywhere from mild to deep. And, of course, it’s those deep recessions that we’re likely to remember.
Recent deep recessions
The last two recessions we experienced are categorized as deep recessions, so it makes sense that the term recession stirs up negative associations among Americans. Let’s take a closer look:
- 2000 – 2001 recession: This recession was preceded by a boom in dot-com companies, which caused their stock values to soar, despite a lack in revenue. Significant overvaluing of this sector eventually led to its correction and subsequent collapse. Manufacturing declines, the 9/11 attack, Fed rate hikes, as well as the collapses of Enron and WorldCom worsened the recession.
- 2008 – 2009 recession: While triggered by the bursting of the housing bubble, many other events contributed to “The Great Recession” — the subprime mortgage crisis, Bear Stearns collapse, Lehman Brothers and Washington Mutual bankruptcies, and the government bailouts of AIG, GM, and Chrysler.
Both of these deep recessions resulted from the inevitable bursting of overvalued market sectors. And both led to market declines of 40-50%, as the equity markets sharply corrected, and high unemployment rates. Americans felt these effects deeply — retirement savings plummeted, job losses soared, and many people struggled to afford basic necessities, like housing, food, and clothing.
For 2023, however, we’re in a reverse situation. Whereas the economies of 2000 and 2008 were floundering, the Fed is currently trying to reign in our soaring economy (and the resulting inflation). And that’s why economists are projecting relatively flat growth, or possibly a mild recession, for 2023 — which is a significantly different, and much better, outlook than what we experienced during the prior two recessions.
How did we end up here?
So, what happened to bring us to the point of a possible mild recession? Inflation. Let’s rewind to 2020, when the Covid pandemic began. No one knew what to expect: Would the markets crash? Would small businesses buckle? Would unemployment soar? Given these significant uncertainties, the government attempted to stimulate the economy through stimulus payments, extra unemployment benefits, small business loans, hospital payouts, and more. And while these methods succeeded in boosting the overall economy, they also led to record-breaking inflation.
Fast forward to 2022, when inflation was steadily rising and Americans were feeling it in their wallets. The Federal Reserve’s primary means of curbing inflation is to raise the federal funds rate, which has a trickle-down effect because it influences the prime interest rate. Attempting to cool the economy and gradually lower inflation, the Fed has raised rates 10 times since March 2022.
As we move through 2023, we’ve seen that the Fed’s rate increases have effectively slowed the economy. And, on one hand, that’s good — they’ve curbed inflation and avoided a hyperinflation situation, which in many ways is worse than a recession, while also keeping unemployment low. But, on the other hand, the rate increases have tightened the equity markets and reduced our purchasing power. And when Americans can’t afford to spend, take on new loans, or extend credit card debt, GDP ends up contracting — and negative GDP is the primary recession marker.
The sky is falling…or is it just cloudy?
Let’s set the record straight: We don’t think the sky is falling. Is it likely that the equity markets won’t grow, producing flat returns instead? Yes. Is it possible that GDP will decline slightly, creating a shallow recession? Yes. Are there fewer market and investment opportunities available for 2023? Yes.
But do we expect unemployment to reach deep-recession levels of 10 – 15%? No. And the unemployment rate is arguably the most important indicator as to how deep a recession might be. So as long as unemployment remains low, which is what economists are expecting, this period of economic contraction will likely be short lived.
Given the lack of growth opportunities we expect over the next couple quarters, we’re expecting a flat year for the equity markets — put simply, the forecast is dull and cloudy. That said, there are pockets of opportunity within the fixed income and global markets, which we expect to capitalize upon.
Limiting the effects of a recession
About 15 years ago, my wife and I decided to run a half marathon. We followed a beginner’s training plan, learned to enjoy running, and completed the half marathon. But when my knees started to pay the price, I had a decision to make: Do I keep running, risking further damage to my knees, or do I transition to a different area, allowing my knees to rehab and heal? I decided to take up cycling — a sport that offers comparable benefits, but is much easier on the knees.
Potentia Wealth recently faced a similar decision when it came to the equity and fixed income markets. Should we keep focusing on equities, where we expect flat returns at best? Or do we allow the equity markets time to “heal” by transitioning our portfolios toward fixed income, an area we believe could produce significant gains for the first time in more than 15 years?
As you probably assumed, we chose to hedge client portfolios against a possible recession by adopting a conservative equity strategy and an aggressive fixed income strategy. For example, we carefully combined high-yield bonds with investment-grade bonds to potentially provide steady returns for 2023 and the coming years. And we shifted our equity holdings toward value-oriented, dividend-paying blue-chip companies. We also are strategically focusing on a few global areas in the equities markets that we consider niche growth opportunities.
Let’s maintain proper perspective
The economy affects your family, your wallet, and your legacy, so it’s understandable why many clients have expressed worry and concern over what lies ahead. But let’s avoid a “sky is falling” mentality — even if we do enter into a recession, it’s likely to be mild and short lived.
It’s also important to remember you’re not alone — your partners at Potentia are working hard to position your portfolios to handle the lethargic equity markets, profit from high fixed-income yields, reap long-term benefits from investment-grade bonds, and capitalize on niche sectors of potential growth. Thank you for allowing us to steward your portfolios and partner together to meet your long-term goals.
©2023 Potentia Inc.