Recession or no Recession - Does it matter?

Canada’s Media has recognized the power of the word Recession and started using it. Something our southern neighbours have been doing for a while, especially politicians.                                               

Do we have a recession and if so, what does it mean?

Let’s look at the US, since most of the fear mongering originates there and that economy still determines what happens in the rest of the world, including Canada.
Historically, A recession is generally defined as two consecutive quarters of negative GDP growth, as measured by the Bureau of Economic Analysis (BEA).

However, more recently we learned that a recession is in fact designated and dated by the National Bureau of Economic Research (NBER), who make the call when they see a “significant decline in economic activity that is spread across the economy and that lasts more than a few months.” The variables the bureau emphasizes include income, employment, personal consumption, and industrial production.

That said, this exercise of defining recessions isn’t very productive. It’s mostly just semantics and is highly dependent on the metrics you decide to include and exclude in how you calculate economic activity. So, if we are in a recession or not depends on who you ask. A democrat will describe a very different state of the economy than a republican and most likely neither will be correct.  

One thing everyone can agree on is that much of the economy is slowing. In fact, the BEA says GDP contracted at a 1.6% rate in Q1, and the Atlanta FED’s GDP Now model is pointing to a 1.2% contraction in Q2. But some very visible aspects of the economy are holding up very well.

Jobs growth While there have been signs the jobs market has been cooling, it certainly does not reflect an economic recession. According to Bureau of Labor Statistics (BLS) data released last Friday, U.S. employers in June added a healthy 372,000, which was considerably stronger than the 265,000 expected by economists. Total employment stood at 151.980 million, which is up 21.467 million from its low in April 2020. It’s now just barely below its pre-pandemic level of 152.504 million in February 2020. So while the stock market had it’s worst first half of the year since 1970 and economic activity has accelerated since the beginning of the year, the labor market has added 2.74 million jobs during the same period with gains in every month. Also, the unemployment rate remains very low at 3.6%. This is in line with BLS data released on Wednesday that showed the layoff rate remained near a record low of 0.9% in May. More recent unemployment claims data also suggests that the jobs market is in pretty good shape. Initial claims for unemployment insurance came in at 235,000 for the week ending July 2. While the number is up from its six-decade low of 166,000 in March, it remains near levels seen during periods of economic expansion. 

So, if the economy is in a recession, employers have not seemed to notice. What about the future? Based on job openings data, it’s clear that the demand for more labor continues to be very strong. According to BLS data released Wednesday, there was a whopping 11.25 million job openings in May. That compares to the 5.95 million unemployed during the same period. With nearly two job openings per unemployed person, this is a very tight labor market with a lot of demand for workers.

Why this is not a recession “In recent decades, the two measures we have put the most weight on are real personal income less transfers and nonfarm payroll employment,” the NBER explained regarding its recession calls. Indeed, according to Deutsche Bank’s analysis of recessions since 1939, the first month of a recession on average sees a decline in jobs. And we haven’t seen a decline in jobs since December 2020. Regarding real personal income less transfers, that metric also continues be very strong. According to BEA released June 30, it climbed to a record annualized rate of $14.5 trillion in May. 

The BLS also has a metric called the index of aggregate weekly payrolls, which is the product of jobs, wages, and hours worked. It’s a rough proxy for the total nominal spending capacity of the workforce. This metric increased by 0.6% month-over-month in June to a record high of 172.4, reflecting a 9.4% jump from a year ago. Before the pandemic, the annual growth rate was trending at around 5%. When incomes are rising, so is the capacity to spend. And consumers are spending.

Strong jobs data is good. However… These labor market trends are obviously good news for those getting new jobs as well as those who aren’t getting laid off. But there is the risk that this good news and the incremental consumer demand that comes with it puts continued pressure on the supply chain, which is inflationary. That’s bad news as the FED’s top priority right now is to bring down inflation, even if it means employing tight monetary policy which does some serious damage to economic activity.

Good News On an encouraging note regarding inflationary pressures, average hourly earnings in June increased by just 0.3% from May. This reflects a 5.1% gain from a year ago, which is down from 5.3% in May, 5.4% in April, and 5.6% in March. While the level of job openings remains very high, it has been declining from it’s March high of 11.9 million. This should further help ease wage pressures, and in turn inflation should come down.

Gas prices are falling. According to AAA, the average price of a gallon of regular unleaded gasoline was $4.684 on Sunday, down from $4.812 a week ago. Prices touched a record high of $5.016 on June 14. 

That said, we seem to be a long way from getting “clear and convincing” evidence sought by the Fed that inflation is on its way lower. And until we get that evidence, expect the FED to continue to tap the brakes on the economy. Another mistake in my opinion. Interest rates increases address demand, not supply which is the issue. Ignoring current high inventory levels is a mistake that could prolong the problems. The strong labor market is keeping the economy from tipping into a recession for now. But the longer the Fed will tighten monetary policy aggressively, the more likely it becomes that people start to lose jobs. 

The NBER defines a recession as “a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee's view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another. There is no fixed rule about what measures contribute information to the process or how they are weighted in our decisions.” One widely known criticism and flaw of the GDP calculation is that net imports are negative. In other words, if the U.S. economy is relatively stronger than international economies and that’s causing imports to outpace exports, then GDP suffers.

Bottom line is that there are certainly problems, but these are not new problems and not unsolvable problems. The word recession is being used, misused and abused like never before. By the media to seek attention, by salespeople trying to sell solutions like Gold or Bitcoin and by politicians, trying to manipulate peoples mind to gain an edge on election day. If you are a trader it matters since you are looking for daily or even hourly swings. If you are a mid- or long-term investor not so much. While it’s difficult to stay calm during falling markets and with all the fear selling around you, as long as your portfolio is well balanced, diversified and contains Equity and Fixed Income components that will participate in the rebound, you are in a good position. I haven’t given up on this year yet and still see a possibility that we could have a significant rally before the end of the year. Markets are based on economies and these are subscribing to Business Cycles, made up of Expansion Periods and Contraction Periods. While we dislike the Contraction part, they are always followed by Expansion.

Falk Hampel