Let’s first define a recession. In order to have an official recession, we must have two consecutive quarters of negative GDP. Gross Domestic Product (GDP) is, in layman terms, all the money spent by individual consumers, business firms and the government.
Thus far, we have the number from the third quarter of 2007 and it showed a positive increase of 3.9%. We will have to wait a couple more weeks before we get the 4th quarter number, and it's estimated to be flat, but will likely be revised a time or two.
Therefore, in order to officially call a recession, we have to wait eight months in order to get two consecutive quarters of GDP measurements. That's a long time to be patient as we watch the market erase all of last year's gains in a matter of weeks.
Let’s step back and take a look at how we got here.
Remember the market boom of the late 90’s and the bust that followed? You see, booms don’t just precede busts, they also cause them. In response to the last bust, the Federal Reserve went on an interest rate cutting campaign that pushed us to 40 year lows. These bargain basement interest rates served as a potent stimulant, which led many to borrow more than they might have at higher rates thus stretching their dollars. Also, with low rates businesses stocked up on labor, machinery, buildings, etc. Consumers bought cars and houses (sometimes 3 or more houses) over the past five years and as a result GPD has soared.
However, just like the boom of the late 90’s, we have gotten ahead of ourselves; greed has given way to common sense. Whether it's a dot com stock or a condo in Miami, prices can’t keep rising forever. Because as prices rise, so too does inflation. And as inflation becomes a concern, we start to doubt our prosperous future. As the future darkens, businesses question the credit worthiness of consumers. As consumers feel the pressure to repay, they tighten up their spending. As spending tightens, we see GDP go down…. Which is where we now find ourselves
Back to the present situation.....
Instead of focusing on whether or not the market is in an “official” recession we should determine if the Market is acting like we are in a recession. Markets are forward looking vehicles, typically predicting events six to nine months in the future. The Stock Market started its significant retreat from an all time high in October of last year, falling about 14% to its current level. Based on the market's past predictability, the recent decline tells me that the 4th quarter GDP number is likely to be flat or positive, but that the first two quarters of 2008 are going to experience negative growth.
When will we know if the markets correct? For that number, we’ll have to wait until August of 2008. Remember the eight month delay?
Here’s the catch. If we actually wait until August to call an official recession, the market should be poised for recovery. In fact, the average return of the S&P 500 for the six months immediately after a recession is 12%. So when (or if) the U.S. economy actually experiences two consecutive quarters of negative GDP growth, I would think that’s a pretty good time to buy.
My original question was, are we in a recession? The answer: probably.
Word of caution though, don't dwell on the dreaded "R" word.
Most recessions last between 6 and 18 months. In fact, of the last nine U.S. recessions, the average length has been 11 months. So in theory, if it takes 8 months to call a recession, then we would be out of it 3 months later. That's no time in the grand scheme of economic things.
If we can learn anything from the markets and their cyclical patterns, it should be this: look to the future. People equate a recession with fear and negativism. However, if we can start to change our thought pattern and become more forward looking, we might just find some incredible bargains. A proverb states, "Watch for large problems, they signal larger opportunities" and famed investor Lord Templeton once uttered, "I always profited most at the time of greatest pessimism."
And the real truth here is that a true recession, once realized is both half-over and always precedes prosperity.
This column is for entertainment purposes only and should not be construed as investment advice. Please view our complete disclaimer here.
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