Who calls a recession and how?

The first half of 2022 was unpredictable and difficult for many around the world. The question of impending recession is something we’re hearing frequently from clients and a topic that has dominated financial news headlines. The question is understandable, given the volatile markets and the S&P’s major declines, and provokes another question of who calls a recession and how?

In 1974, economist Julius Shiskin published a point of view for the New York Times noting 65% of the population believed the U.S. was in a recession. He went on to outline several measures he believed to be accurate gauges for calling a recession, with one of them ending up to be what many analysts now globally reference today: two consecutive quarters of negative growth in a country’s gross domestic product (GDP).

Shiskin adapted his measures from the private agency that chronicles, defines and calls recessions for the U.S., the National Bureau of Economic Research (NBER). The NBER does not accept the two-quarter decline as the sole definition of a recession for several reasons, one of them being that an accurate measure should include the depth of the decline in economic activity, not only duration.

The NBER defines recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months” and uses three criteria, depth, duration and diffusion, to measure said decline. The International Monetary Fund (IMF) uses a similar definition for a global recession and notes that many globally synchronized recession episodes also coincide with U.S. recessions, due to the U.S. being the world’s largest economy with strong trade and financial links to other economies.

Many economists and the NBER itself often do not have the data necessary to measure a recession until after it has occurred, adding yet another challenge to the already difficult task of analyzing whether conditions are present for one to happen. Our Investment Strategy Group (ISG), which use a variety of leading economic indicators to gauge recession risk, assigns a 25 - 30% probability of recession within one year and a 45 - 55% probability within two years.

As such, we continue to focus on offering clients customized guidance for navigating uncertain landscapes. Here are two key things to remember:

• Your advisor is focused on managing and, if necessary, rebalancing or exploring investment vehicles that can hedge against volatility or position you to take advantage of market dislocations.
• Incorporate the lessons of the past in your investment decisions. ISG relies on analysis of past economic, political and market developments to guide our expectations for the future. Because a recession is not a certainty today, investors must weigh the opportunity cost of pulling out of a market that has already suffered a sizable decline. As seen in the exhibit below, equity returns a year after the market reached bear market territory have been attractive.

S&P 500 Return in 12-Months After 20%+ Pullback in Calendar Year (post-WWI)