Economic growth has gone backwards, but the circumstances surrounding this downturn seem different than those of past recessions.
With the US Federal Reserve last month talking up the need to do whatever it takes to crush inflation, it has also signalled that the economy could be caught up in the crossfire.
However, the central bank recognises the importance with which it must act in hiking interest rates in order to drive inflation lower.
In the meantime, economists and observers are divided over whether the US economy is already in a recession, or if it is heading towards an unavoidable downturn?
How recessions are defined
One of the longstanding views in financial circles is that two consecutive quarters of negative GDP growth represents a recession.
Some readers will be aware that the US economy contracted by 1.6% in the first quarter of 2022, and then contracted by 0.9% in the June quarter.
So is the US already in a recession?
While that may be the most commonly understood definition of a recession, the official confirmation of a recession is done by the National Bureau of Economic Research.
The Bureau typically doesn’t declare a recession until well after one has passed, however, its definition of a recession is a little more broad. Their criteria includes a “significant decline in economic activity spread across the economy”, lasting more than a few months.
That definition provides more pause for thought, since it is open to interpretation in light of the current economic circumstances. It clearly alludes to a downturn across the economy, which implies factors like the jobs market, consumer spending, business investment, and so forth.
In any case, this is not to say the two quarters of negative economic growth we have seen will not signal a recession in due course. After all, the prior 10 occasions where this occurred resulted in a recession eventually being declared.
The current state of affairs in the US
Although recessions may have been confirmed in each of the previous instances where the technical GDP threshold for a recession was breached, the accompanying circumstances this time around are markedly different.
The biggest differentiator is the current state of the jobs market, which remains incredibly strong, and goes some way towards dispelling the notion that the US economy is already in recession.
For 20 months in a row, the US economy has been adding hundreds of thousands of jobs every month, even as business investment has been pared back. At the same time, vacancies are also sitting at elevated levels.
In the most recent jobs report, 315,000 jobs were added across the US economy in August. The unemployment rate did, however, increase to a six-month high of 3.7%.
There is a possibility the new hires figure may be revised higher, as it often has during previous August figures. Over the last five years, the average revision to August data has seen an additional 120,000 jobs added in the next update.
At first glance, the headline figures may suggest things are starting to unravel in the jobs market. However, on its own, the data provides no context as to what is transpiring at this time.
First, last month’s rising unemployment rate comes off what was a pre-pandemic low of 3.5%. Importantly, total employment is now at a level where there are 240,000 more jobs than before the pandemic.
Secondly, the higher unemployment rate was due entirely to higher workforce participation across the economy. Throughout August, nearly 800,000 people entered the workforce, resulting in a record labour force size.
These jobs are also being spread across various areas of the economy. The services industry added 68,000 jobs last month, healthcare added 48,000 jobs, and there were 44,000 new hires in the retail segment.
Meanwhile, the leisure and hospitality, manufacturing, and construction sectors added 31,000 jobs, 22,000 jobs, and 16,000 new hires respectively.
Thirdly, combined with moderate wage growth, the data gives rise to some optimism that the Federal Reserve may be able to achieve a soft landing for the economy.
Beyond the jobs market, there are also some other signs that suggest a recession is unlikely to be occurring at this time, and may not happen after all.
On the one hand, as we have previously spoken about, there are some positive indicators that suggest inflation may have already peaked, or at least is in a position to start levelling off.
Although falling commodity prices would typically be a warning sign about the risk of a recession, in this instance we believe it is a net positive given the downward pressure that may flow through to businesses facing inflationary costs.
So with commodity prices easing somewhat, this is one of the key levers in reducing inflationary pressure.
The other watch-point is consumer spending, which although moderating somewhat, still appears to be in reasonable shape given the level of concern among households about inflation and the rising cost of living.
Take for example, the likes of Walt Disney (DIS). Unlike some of the more traditional bellwether stocks in the retail, or even consumer technology sectors, Disney provides us with some insights regarding the strength of discretionary spending in the leisure segment.
The company recently reported that revenue at its theme parks is up 70% versus the same period last year, and on a per capita basis, it is 10% higher. Compared with pre-pandemic levels, per capita spending is 40% higher, something that is hardly indicative of a recession.
Extraordinary times like no other
One thing is for certain, we are currently in a period of time that does not have a direct comparison. Some onlookers may draw comparisons to the stagflation period in the 1970s, but there are distinct differences surrounding the macro environment.
The current uncertainty is something that is weighing on the market, with investors anxious about the risk of a recession, especially one that could turn into a prolonged downturn.
With one shock after another for the economy in recent times, we are by no means out of the woods at this time. That makes it difficult to forecast what may lie ahead.
The risk of a recession could very well boil down to a host of external factors, like the war in Ukraine, which the US has little direct control over.
It is our view that a recession in the US can be avoided, albeit the Federal Reserve has a tough act ahead to balance everything.
If a recession does take hold, it may even turn out to be one that only affects certain areas of the economy, and not in nominal terms at large. That in itself could give rise to compelling long-term buying opportunities.
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