By Nancy Johnshoy, CFA, Vice President – Market Strategist
Starting back in early 2018, investors began fretting over the potential advent of a recession, preoccupying over potential signs and signals of an end to our long expansion. Despite the accompanying heartburn, recessions are a natural part of the economic cycle. Given that we are most certainly in a recession now, brought about not by any of the traditional triggers but by a novel coronavirus, I thought that it would be worthwhile to take a closer look.
Since the Great Depression in the early 1930s, the U.S. economy has experienced 14 recessions. Looking all of the way back to the Great Depression (1929-1938), we see one of the early examples of a government spending program designed to stimulate consumer demand: President Roosevelt’s “New Deal.” This took the form of a wide variety of new agencies and laws that created “capitalism with safety nets and subsidies.” These initiatives rolled out over a period of several years from 1933 to 1937 and created many organizations and safeguards that we continue to rely on today, including the Securities and Exchange Commission, Federal Deposit Insurance Corporation, Social Security, and the minimum wage. These initiatives, along with the increased spending for World War II, ended the depression.
“Rolling Adjustment” Recession
In the 1960s, we have another example of stimulus spending to end a recession. The 1960 recession was relatively short, only ten months, but occurred just prior to the election. President Kennedy ran on a core promise to “get America moving again.” Billions were pumped into the economy through increased government spending, lowering the fed funds rate and open market purchases of Treasury notes. These moves set the stage for a long expansion that lasted for almost nine years.
Oil Crisis Recession
In 1973, we experienced the first of several recessions caused by an oil crisis. The Organization of Petroleum Exporting Countries (OPEC) imposed an embargo against the U.S. and other countries in retaliation for perceived support of Israel. Dependent on foreign oil, the U.S. saw oil prices quadruple. That, combined with other factors like wage-price controls, led to five quarters of negative growth and unemployment that peaked at 9%.
Energy Crisis Recession
When I began my career in the mid-80s, the economy had recently emerged from two fairly short recessions that occurred only a year apart, a so-called “W” shaped recession. These recessions were largely caused by the Iranian Oil Embargo in 1979 and a period of a rapidly increasing federal funds rate to combat steep inflation. During this time, the prime lending rate reached a peak of 21.5% and unemployment rate topped out at 10.8%.
Gulf War Recession
First Business Bank, which just recently celebrated its 30-year anniversary, was founded by Jerry Smith in the face of another recession. This time, the economic downturn, which lasted only eight months, was brought about after a lengthy period of expansion during the 1980s when inflation surged and significant debt was accumulated. An aggressive round of fed funds rate increases in 1989 and 1990 designed to combat inflation and slow growth tightened conditions to the point of a mild recession. A contributing factor to this brief recession was tension leading up to Iraq’s invasion of Kuwait in summer of 1990. The economy shed 1.623 million jobs, concentrated mainly in manufacturing and construction, and the unemployment rate continued to rise to a peak of 7.8% in June 1992. So although growth was back on track relatively quickly, this is characterized as a jobless recovery where employment continued to lag.
First Business Bank’s Private Wealth team was founded in 2000 shortly before another short eight-month recession. Beginning in March 2001, this recession brought to a close a ten-year period of expansion and saw a GDP decline of only .3% and unemployment that rose to 6.3%. The primary cause of this short blip was the dotcom bubble, the 9/11 terrorist attack on the United States, and a series of major accounting scandals.
The Great Recession
The Great Recession, which officially began in December 2007, lasted 18 months and was more significant both in the decline of GDP growth and loss of jobs than any period in U.S. history since the Great Depression in the 1930s. The U.S. economy, which saw a decline in GDP of -5.1%, took several years to fully recover, not regaining its pre-crisis peak until the third quarter of 2011. The economy shed 8.7 million jobs from February 2008 to February 2010 and unemployment peaked at 10% in October 2009. The job market did not fully recover to the levels prior to the recession until May of 2014.
Many factors contributed to the Great Recession, including vulnerabilities and structural weaknesses in the financial system, excessive borrowing and risk taking by consumers and corporations characterized by the inappropriate use of leverage, the explosion of sub-prime securities and usage of derivative securities as a tool to amplify return. The canary in the coal mine for this recession was a liquidity crisis in the financial sector. Investors will recall the government bailout of AIG, which was the insurer of the liabilities for most major financial institutions, the Lehman Brothers bankruptcy, and Countrywide Financial, IndyMac and Washington Mutual to name a few other institutions that did not survive the crisis. Seeking to prevent the total collapse of the financial system, then Treasury Secretary Henry Paulson proposed that the U.S. government purchase several hundred billion in distressed assets from banks. That plan was initially rejected by Congress but as the crisis endured and intensified, the Emergency Economic Stabilization Act of 2008 was passed. The Act authorized the federal government to purchase and insure certain types of troubled assets to provide stability to the financial system, a program known as the Troubled Asset Relief Program (TARP). The Act also included various tax breaks and relief for the middle class and a provision to raise the cap on FDIC insurance for bank deposits from $100,000 to $250,000. In a classic example of “pork,” the Act also included a number of tax breaks for special interests, including wool research, certain wooden arrows designed for use by children, auto racing tracks, and mine safety equipment. There was significant public debate over TARP and what was perceived as a bailout of the banking system (“too big to fail”). In the end, the TARP program yielded a profit to the U.S. government as $626 billion was loaned and a total of $713 billion in principal and interest was repaid. Overall, the price tag on the economic rescue package was a $700 billion bank bailout and a $787 billion fiscal stimulus package.
As we know, the Great Recession officially ended in the second quarter of 2009, but the U.S. economy continued to languish for several years after. Lasting damage to the banks and the housing industry caused headwinds for several years following the end of the recession. Median family net worth stalled as many middle-class families had much of their wealth in housing and retirement assets, both of which declined significantly in value during the recession. Real GDP per capita fully recovered in the fourth quarter of 2013 and employment recovered to the pre-crisis peak in May 2014. Although not overly robust in terms of GDP growth, the economic expansion that followed the Great Recession was the longest since 1900.
The modern definition of a recession is a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Without waiting for the National Bureau of Economic Research (NBER) to officially declare this recession, we know just based on the dramatic decline in business activity accompanying the efforts to contain the spread of COVID-19 that we most certainly are in a recession. As the old saying goes, if it walks like a duck and quacks like a duck, it’s a duck. We cannot know today what the severity or duration of this recession, already termed the Great Lockdown, may be. Certainly the rapid and significant response by both the Federal Reserve and the federal government aimed at keeping markets running smoothly and helping to get funds to individuals and businesses negatively impacted by the economic shutdown will help to minimize the damage. So far, the various stimulus programs, including the Coronavirus Aid and Relief Economic Security Act (CARES) already total many trillions (yes, trillions!) of dollars. The amount of stimulus funding has been likened to “war time” spending. Indeed we are at a point now where the stimulus packages as a percent of GDP is the highest since 1945.
Common themes that most recessions have in common are rising oil prices, inflation, and aggressive monetary policy. A spike in oil prices has preceded nine out of 10 post-WWII recessions. This is definitely not the case today as oil prices have dropped to prices last seen in 1986 due to lack of storage capacity and rapidly declining demand. Inflation has not been a problem since the 1980s and that remains the case today. Monetary policy also is not a contributing factor with the federal funds rate target currently at 0 – 0.25% and ample liquidity in the financial system. Indeed, in this case, the economic expansion was sacrificed for the sake of public health and we are deep in uncharted waters.
Here are a couple of final thoughts on recessions: The United States has experienced 33 recessions since 1857, averaging about 17.5 months. More recently, since 1960, recessions have been shorter in duration, averaging only 11 months. Expansions, on average, have been longer at almost five-and-a-half years versus the longer-term average of three-and-a-quarter years. Many believe that the pace of a recovery from this recession is largely dependent on the expansion of virus testing capabilities and development of a vaccine for COVID-19, making it very difficult to predict the path of recovery.
Stock markets do always fall during recessions. The degree to which stock prices decline is greatly affected by how long the recession lasts, the severity, and valuation levels when the recession begins. Stock prices are closely tied to corporate earnings, which, in turn, are tied to economic activity. The last two recessions (2000 and 2007) saw stock market declines of 49% and 57% respectively. The most recent decline of 57% in 2007 paved the way for a 400% increase over the course of a 133-month bull market. The COVID-19-related market downturn saw a rapid decline of 34% from the peak in February over only 23 trading sessions. The market rallied up off the bottom to post a gain of 25% over the next 21 trading sessions. As we sit today, the market, as measured by the S&P 500, is off just over 13% year-to-date. Certainly this was the most condensed market cycle on record and exemplifies our often repeated caution against trying to time the market.
|Time Frame||Duration||GDP decline||Time Since Previous Recession||Peak Un-employment||Characteristics / Primary Cause|
|4/1960 – Feb 1961||10 months||-2.4%||2 years||7.1% in May 1961||“Rolling Adjustment” Recession: Short recession occurred when Fed began raising rates in 1959. It was followed by what was at the time the longest period of expansion since the Great Depression.|
|Dec 1969 – Nov 1970||11 months||-0.8%||8 years and 10 months||6.1% in Dec 1970||The Nixon Recession: Short and mild. Inflation rose after a long expansion, corresponded with a federal reserve monetary tightening cycle.|
|Nov 1973 – Mar 1975||1 year and 4 months||-3.6%||3 years||9% in May 1975||Oil Crisis Recession: Major contributors were the oil crisis of 1973 and high government spending on the Vietnam War. The stock market crash which resulted in the loss of 45% of its value.|
|Jan 1980 – July 1980||6 months||-2.2%||4 years and 10 months||7.8% in July 1980||Energy Crisis Recession: A very short recession followed by a short period of growth and then a longer recession. Brought about by the Federal Reserve raising rates to combat high (13.5%) inflation.|
|July 1981 – Nov 1982||1 year and 4 months||-2.7%||1 year||10.8% in Nov 1982||The Iran/Energy Crisis Recession: Continuing effects of the oil crisis from the 1970’s, continued rate hiking cycle caused this “double dip” recession. The prime lending rate reached 21.5% in 1982. This recession was followed by a long period of expansion.|
|July 1990 – Mar 1991||8 months||-1.4%||7 years and 8 months||7.8% in June 1992||The Gulf War Recession: Increased inflation brought about a rate hiking cycle that lasted from 1986 to 1989. Contributing factors were oil price shocks due to unrest in Kuwait and higher debt levels.|
|Mar 2001 – Nov 2001||8 months||-0.3%||10 years||6.3% in June 2003||The 9/11 Recession: Following 10 solid years of growth, the collapse of what is referred to as the “dot-com bubble” and the September 11 terrorist attacks. Recession was very brief and mild.|
|Dec 2007 – June 2009||1 year and 6 months||-5.1%||6 years and 1 month||10% in Oct 2009||The Great Recession: Collapse of the housing market and the sub-prime mortgage crisis led to a cascade of financial institution and corporate failures. Stock markets lost -57% of value. 9 million jobs were lost.|
|March 2020 – ?||?||?||10 years and 9 months||?||Then longest economic expansion was ended not by oil shocks or higher interest rates but by a novel coronavirus, resulting in quarantines, travel restrictions and safer-at-home orders across the country. As of April 24, over 26 million workers have filed for unemployment benefits.|