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It’s likely no surprise that we’re in an economic recession.
On Wednesday, data showed gross domestic product (GDP) dropped 4.8% last quarter (on an annualized basis) after U.S. economic activity ground to a halt in March.
Economists surveyed by Bloomberg currently estimate GDP will slide another 27.3% in the second quarter as the shutdowns continue. Two quarters of declining GDP is the classic definition of an economic recession.*
Every recession is different, and this iteration is especially unique. The U.S. economy is battling two shocks at the same time – coronavirus and oil. While it has been an uncomfortable few weeks, there’s a road map from past recessions that investors can use to navigate these turbulent times.
Follow the directions.
Recessions are typically quick and severe, like a spring thunderstorm. The 10 recessions since 1950 have lasted an average of 11 months (compared to an average of five years for 10 expansions since then). The longest was an 18-month recession from 2007 to 2009 (the Great Financial Crisis), and the shortest was a six-month recession in 1980 (when the Federal Reserve fought high inflation).
This time around is especially unique given the unprecedented speed and magnitude of the slowdown. Jobless claims have surged to record highs, some companies have stopped hiring, and consumer spending has fallen off a cliff. Since 1950, the largest quarterly drop in GDP has been 10%, and Wall Street thinks we could see a contraction double (possibly even quadruple) that size in the second quarter. Those are stunning numbers.
Luckily, history shows that growth bounces back quickly after a recession runs its course. Since 1950, GDP has risen an average of 5.1% in the four quarters after a recession has ended, compared to 2.9% in all other quarters. There’s also evidence that the U.S. economy recovers from weakness especially quickly when the financial system stands firm (according to this Stanford study). Wall Street expects the recession will end this summer, predicting GDP will rebound 9% in the third quarter and 6.9% in the fourth quarter.
Stocks as Your GPS
Stocks could be your GPS, as they’re typically a good barometer of where the economy is heading in the near term. In fact, markets typically sniff out recessions before they happen. In eight out of the last 10 recessions, the S&P 500 peaked within a year of when the recession started. It looks like we may be in the same boat today: The benchmark reached its last high on February 19, and the recession started right after that.
The same is true on the other end: Stocks have historically bounced before the economy. In seven out of those 10 recessions, the S&P 500 bottomed four and a half months before the next economic expansion started.
Stocks can give bad directions, though. In late 2008, the S&P 500 climbed more than 18% on two separate occasions before reaching its March 2009 low. The recession ended three months later.
An Alternate Route
Stocks can also diverge from economic reality for various reasons. The current disconnect shows investors may have found solace in an alternate route: extraordinary policy measures. The Fed has cut interest rates to zero and enacted trillions in various bond-buying and lending programs. U.S. lawmakers followed the Fed’s lead, implementing trillions in fiscal stimulus to provide cash to consumers, aid businesses and enhance unemployment benefits. In response, the S&P 500 has rallied about 27% since March 23.
These historical policy actions could help support the economy and ultimately shorten the recession. But eventually roads converge, and markets will need to reconnect with the economic fundamentals.
Fed Chair Jerome Powell warned on Wednesday that there are “considerable” medium-term economic risks that could persist over the next year. He reiterated that the Fed is committed to help as long as needed, but his language didn’t convey the “all clear” signal we’re seeing in stocks.
Are we there yet?
It’s still not clear when this downturn will end, or when stocks will definitively push back to new highs. Investors think we’re close, but we’d caution against declaring victory just yet.
The timing of this recovery is still uncertain. The economy’s response depends on how effectively government officials can open local economies back up without re-igniting the coronavirus outbreak. Beyond that, there could be collateral damage from the economy shuttering for several weeks (in many states, shelter-in-place orders have been in effect for seven weeks). A swath of businesses may not survive, and consumer spending may not come back at full strength. Besides, other markets, like Treasury yields and oil, aren’t buying the optimistic narrative yet.
There could be a winding road ahead.
*We’d ideally cite the National Bureau of Economic Research’s recession definition (as it is more comprehensive). However, the NBER typically labels recessions retroactively, so we may not get the NBER’s final verdict on the size and scope of this particular recession until it’s over.
The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.