Menu
Is a recession on the horizon? Or perhaps, are we currently in the middle of one? This blog provides you with all the essentials!
When you hear the word recession, words such as hardship and prolonged depression likely come into your head. It may also lead you to reflect on your own experiences in the previous recession, as they tend to be more frequent nowadays. With that said, a recession shouldn’t necessarily ring the alarm bells as some are rather short-lived, such as the March 2020 pandemic crash for example. Let’s go through the fundamentals of a recession.
A recession is widely known as a period of downward production and employment, which in turn leads to a halt in income and household spending. More specifically, the economic definition of a recession is two consecutive quarters of negative GDP (Gross Domestic Product). GDP is a measure of economic growth within a country, and therefore two consecutive quarters of negative GDP indicates a serious problem within an economy. Additionally, recessions have no pre-determined duration and their length can depend on a number of factors. Take the last two recessions as an example.
The collapse of the housing market in 2007 led to what is now known as “The Great Depression”. The duration of this was approximately 18 months and resulted in a 4.3% GDP decline and peak unemployment at 10%. It should be noted, however, that various perspectives on what an actual recession is can affect the way one determines its length. As with the economic definition, it would suggest that the outbreak of the C-19 pandemic led to a short-lasting recession. Moreover, negative GDP lasted just a few months before a rampant surge in asset prices, stocks, and crypto. However, some argue that despite its bounce (largely due to a monetary policy of money printing), we have in fact been in one long recession.
To reiterate, economically speaking, that wasn’t the case. But, opinions on what constitutes a recession may differ from person to person. For the sake of this condensed blog and its discussion of an “upcoming” recession, it will remain with the economic terminology.
Just as determining the definition of a recession can cause subjectivity, the same can be said about the current reasons for why an upcoming recession may be looming. For instance, there are technical indicators, led by decades of data, charts, and graphs, which can illustrate patterns in the lead-up to prior recessions. On the other hand, there are also visual indicators aka the things we see in our day-to-day life such as going to the supermarket to buy food or buying petrol. Additionally, the conversations among family and friends, coinciding with the reinforcement of high inflation on the news lead to concern. Therefore, public sentiment can also be a good indicator.
Firstly, addressing the technical side, the evidence appears to suggest the economy is currently not in a stable position. The clearest indicator staring everyone in the face is the global inflation rate, reaching three-decade high levels in the UK and US. Whilst small amounts of inflation lead to economic growth, this becomes absent once wages fail to keep up with inflation. This is demonstrative at 3% inflation, let alone 7% or 8%. On top of that, GDP growth levels have been decreasing month on month, creeping towards confirmation of a recession.
Last, but certainly not least, a yield curve inversion is considered the final nail in the coffin before an inevitable recession. In a nutshell, the yield curve refers to short and long-term treasury bonds. When the yield curve inverts, 2-year (short-term) are higher than 10-year (long-term) rates. Ultimately, that is the key indicator that illustrates investors are expecting a pause in the economy, whereby the short-term outlook looks better than that further out. Every time the yield curve has inverted, within 12-18 months a recession has hit. Recently, after sitting on the cusp for days, the yield curve did eventually invert.
Secondly, for the most part, it doesn’t require technical indicators to tell us what we can already see in front of our eyes. For instance, 2022 has seen the cost of living becoming eye-wateringly high. On top of rising food prices, the recent conflict between Ukraine and Russia has caused an oil shortage, culminating in razor-sharp prices for petrol in Europe. Similarly, other commodities such as wheat and gold have seen new all-time highs, whilst at the same time, stocks and crypto have struggled. Meanwhile, real estate has been front-running asset inflation, as many people have struggled with affording either mortgage or rent due to increased prices and higher interest rates. These are all indicators that the economy is not feeling confident and risk-off is currently where to be.
It is important to note that just like with investing, past performance is not indicative of future results and therefore an inverted yield curve is not the be-all and end-all. However, with all other factors in the economy considered, you should be prepared for the almost certainty that a recession of some sort is forthcoming. The exodus from risk-off assets such as crypto and stocks has already begun and the movement towards risk-off assets such as cash and commodities is well in swing. This is the most sensible option in the event of a long-term recession so that you have the financial means on hand to deal with whatever unique possibilities may occur.
Having said that, a quick word of caution for those transferring completely to risk-off: the last recession was brief and within months, an all-time high was in for stocks and crypto. This was largely due to the Federal Reserve kicking the can down the road and opening up stimulus cheques. They have the power and capabilities to stretch this out further than most can imagine, and therefore one should consider how much of a cash position you want when it is currently debasing at a stark 15% a year. Unfortunately, a short-term relief will only cause a greater recession down the road and that’s why it is important to invest in sound, hard assets, whilst remaining diligent at all times.
Feel free to share this blog with your social networks!