what we mean by “recession” matters

Good morning, this is Jenn Hughes filling in for Rob. Stocks are unsure what balance to strike between better jobs data so far this week and the risk the numbers pose to hopes for a big rate cut. Again, it all comes down to Friday’s payroll report. Send me your predictions – and alternate must-watch data series: [email protected].

What is in a recession?

Write about the steepness of the yield curve as a recession predictor, as I recently did, and be prepared for a lot of people to tell you you’re wrong.

Relax, it’s not about the curve. And I don’t mind being told I’m wrong. But the responses I got made me wonder if part of the debate is simply differences in what people understand by the R-word.

We’re not that familiar with recessions these days, with only extreme examples, and only two of those, in the last 20 years.

Stocks are near record highs, and while gold is nervously hitting highs as well, there are few other signs that anything bad could be priced in. which are more like the recessions of yesteryear.

At Grant’s Interest Rate Observer conference in New York on Tuesday, there was a clear matter-of-fact tone about the likelihood of a recession — a group that tends to skew older and with more bond watchers and bond bugs. gold.

“We’ve had a lot of recessions in this country, and they basically clean out the rot,” billionaire investor Stanley Druckenmiller, 71, told the conference. “What we want to avoid is a big, bad recession, and those come from loose monetary policy and asset bubbles.”

Asked by host Jim Grant, 78, if he thought there was a market bubble, The Druck, who manages his own money these days, said yes. Equity or credit? both. Sip.

Back to the R word. The basics of identifying recessions are pretty simple. Most countries define a technical recession as at least two consecutive quarters of year-over-year GDP decline. In the US we have the National Bureau of Economic Research, long considered the official arbiter of recessions, which identifies economic peaks (recession starts) and troughs using a wider range of measures.

The declines, however, vary in length and severity, and here recent history does not serve observers well. The 2020 US recession lasted two months, according to the NBER, and is the shortest on record. The 18-month crisis in 2008-2009 was the longest since World War II. Both involved severe shocks, namely the coronavirus pandemic and the financial crisis.

So it’s been more than 20 years since the US experienced what could be considered older more seasoned readers as a typical recession. It’s much easier to scoff at the idea of ​​one now if you think it only matters if it looks as extreme as recent memory would suggest.

But what if the lines between the softer side of the soft landing and the recession were more blurred?

In the eight-month recession of 2001, US GDP fell by about 1% annualized in the first and third quarters (it increased in the second quarter), while unemployment rose from 4.3% to just 5 .5% – lower than any other NBER-defined recession in over 50 years.

Note also that recession expectations do not necessarily increase month by month as the data or markets weaken. Consider the number of articles mentioning recession and the US or the United States of America in the Financial Times, Wall Street Journal, and New York Times, as counted in Factiva. It’s certainly a rough measure, and I wasn’t looking for any misleading mentions, but it’s a reflection of what the institution is discussing.

The chart shows that R-word talk only really jumped toward the end of 2008—after the collapse of Lehman Brothers, and also only when the NBER announced a downturn it said had begun 12 months earlier.

The line shows how the S&P 500 peaked long before recession became the word du jour.

If a recession happens and no one notices – or if everyone sees it at the time as a slowdown or a soft landing – does it really matter to the markets?

That depends mainly on the policy response from the Federal Reserve.

A recent article by State Street’s head of macro strategy, Michael Metcalfe, points out that investors have moved to bonds from stocks in each of the last three rate cut cycles. Based on the bank’s data — and as a custodian, he sees a lot — investors are currently overweight equities, and their shift tends to deepen as rate cuts continue.

(Think of the 20% average in the chart as the gap in a typical 60-40 equity-weighted portfolio.)

“Look at the fundamentals today and this bias towards US stocks is fully justified – if you look at the macro growth, the real gains are profitable for stocks,” says Metcalfe. “But throw it forward, if there’s a higher probability of a recession that we — the market — think, then the overweight in U.S. stocks is probably the biggest risk that we haven’t reduced.”

Perhaps the next quarterly earnings season will paint a more optimistic picture than the last. The largest companies continue to grow solidly, if not quite as strongly as at the beginning of the year. There’s also the outcome of the US election in November to consider. But a subdued economic backdrop is a risk to yields that shouldn’t be dismissed entirely just because it doesn’t — hopefully — end up being a recession for the ages. .

A good read

Have we seen the end of cheap money? The FT’s Martin Wolf asks if the valuation of stock markets has stopped being mean-reversed, even in the US.