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Anticipating The Next Recession

Gray's Papaya counter with sign reading Recession Special Save $1
Gray's Papaya, New York City. Photo by Alan Turkus.

The next recession is coming. While no one knows for sure when it will come, we all know it will arrive eventually. And although a recession doesn’t automatically worry me, I have some concerns about how we as a country will react.

It’s important to understand that recessions are part of the normal economic cycle. While there is nothing pleasant about two or more quarters of declining gross domestic product, no healthy economy can grow continually forever. As the economy grows, not all capital is allocated efficiently, and eventually mistakes must be corrected in the form of job cuts, bankruptcies and other actions, so that the economy can resume its long-term growth.

In America, where approximately two-thirds of economic activity is tied to consumer spending, it’s safe to guess that the next recession will involve a slowdown in consumer spending. There are many possible events that could push our economy into a recession, but it is likely that reduced spending will be the result of job losses, which put less money in consumers’ pockets on average.

How will Americans collectively react when the next recession arrives? The last U.S. recession ended in mid-2009, over seven years ago. Polls show that despite rising economic output and an improving labor market over each of the last seven years, along with a sharp rise in household incomes last year that the Census Bureau reported this week, many Americans believe that we are still in recession. If conditions stop improving and start getting worse, Americans who are struggling will become even more frustrated. And many other Americans will also see their lives, at least temporarily, change for the worse.

Call me cynical, but it is easy to envision our politicians using a recession as an excuse to score political points, rather than working together to improve the situation. Unless conditions in Washington change significantly, members of each party will likely blame members of the other for failed policies creating the recession, rather than accepting any share of the blame or looking for constructive solutions. Democrats will likely push stimulus programs focused on increased government spending, while Republicans will push stimulus in the form of tax cuts. Rather than compromise, the next recession may just wind up as a talking point for the next presidential election, with both sides blaming the other and trying to fire up their base.

Central bankers are responsible for keeping the country’s economy running smoothly, but the tools available to them may be limited when the next recession comes. Unless interest rates are significantly higher than they are now, it’s possible that the next recession could lead to negative interest rate policy (NIRP) in the United States. While central bankers around the world have begun to acknowledge that their decisions are creating unintended consequences that can be harmful to many, they continue to stick to their existing strategies of interest rate cuts and security purchases. This may have as much to do with public perception as actual expected benefits. Raising rates or leaving them alone is just not seen as acceptable for most central bankers around the globe when their economies are struggling.

The longer we have low interest rates in the U.S., the more we will accept low rates as normal. This perception will impact future generations and their attitudes towards saving and investing. It is possible that central banks will create some new tools before the next recession comes. But other than “helicopter money” (essentially central banks adding new money to the economy without any hope or expectation of getting it back), there are few ideas that haven’t already been tried or that are worth serious consideration.

The stock market is generally a leading indicator for predicting the beginning and end of recessions. Many investors do serious harm to their portfolios by getting the timing all wrong and selling stocks after the market has already priced in a recession, and only buying back stocks after the recession has officially ended (and stocks have already recovered). A better approach is to stay disciplined and look for opportunities to buy shares at depressed prices, rather than sell. We have also seen a trend towards investors favoring shares of stable companies with high yields, such as utilities and consumer products companies. While these companies definitely have a place in a diversified portfolio, valuations for many of these companies have become seriously stretched compared to historical averages. In the future, investors may see substantial losses in stock investments that they thought were safer than the market as a whole.

As for the bond market, the timing, severity and duration of the next recession will all determine how bond investors are affected. Interest rates could decline as the stock market falls during a recession. It is also possible that rates could rise, especially for riskier bonds, as investors look to sell as much as they can. Right now our bond market is effectively distorted, with unnaturally low yields, due to global central bank policies. If the next recession arrives before these aggressive central bank decisions are unwound, bond investors looking to sell could face major liquidity issues. If the recession arrives and interest rates have returned to more normal levels, bond investors will likely be better off and could end up with strong returns on their bond investments.

As always, in a recession much of the financial media can be counted on to make the situation worse. It’s not uncommon to see negative, eye-grabbing headlines even when times are good, and the volume is turned up when times are bad. Expect to see headlines with words like “panic” or “crash” on days when the stock market goes down 1 or 2 percent. A move like that is no reason to panic; it just reflects markets taking in new information and adjusting prices accordingly. As always, it will be important to try to distinguish real analysis from attempts to generate clicks or sell advertisements. Unfortunately, many journalists are more focused on the latter than the former.

Since the end of World War II, U.S. recessions have not been nearly as bad as the financial crisis of 2007 to 2009, but there are a lot of young people who don’t know what previous recessions even looked like. For example, the last recession before the most recent crisis was in 2001. It lasted eight months, and GDP dropped by 0.3 percent. Unemployment peaked at 6.3 percent. The last recession before 2001 was worse. It lasted eight months too, from mid-1990 to early 1991. GDP fell 1.4 percent and unemployment peaked at 7.8 percent. These statistics may make our economy seem less volatile than it truly is, and I do not mean to downplay the severity of recessions and the impact they have on people’s lives. But the point is that while recessions happen, they end without taking the global economy down with them. Then growth resumes.

For those who believe we are still in a recession, the next recession will be viewed as validation, and many politicians and financial reporters will make the situation worse by stoking fear and panic for their own purposes. I hope that there will also be loud voices to reassure us all that recessions are normal and to be expected, not something to be avoided at all costs. But ultimately it will be up to each of us to decide how to react when the next recession comes. At Palisades Hudson, I’m sure we will pay close attention and not ignore the situation, but we will also stay calm and avoid letting our emotions get the best of us. We’ve done it before, and we’ll do it again. I hope that others who are in a position of power or carry influence in the U.S. will act the same way when the next recession comes.

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