To understand today’s market climate, we have to look back to 1945
A note from Joel & Rob: Every Monday for the next few weeks, we’ll spend some time digging into the similarities between the post-World War II U.S. economy and today. Keep checking back each week to keep up with our coverage of the timeline.
People can’t stop talking about the downturn our country might be facing. Inflation is high. We’re currently in a bear market. People are still feeling the lasting effects of the pandemic.
But does that mean we’re definitely heading towards a recession? Before we can answer that question, we must really understand the term “recession.” Today, we will explore what a recession really means, and how to prepare for the environment in 2022.
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According to the National Bureau of Economic Research, a recession is a “significant decline in economic activity spread across the economy for more than a few months.” That’s a pretty loose definition.
There are so many factors that play into a recession… like gross domestic product (“GDP”), consumer spending, employment, and household income—just to name a few. All of these components could lead to a “significant decline in economic activity.”
That adds a level of complexity to determining if we’re in a recession. So most people look to the traditional sign that a downturn is on the horizon – two consecutive quarters of negative real GDP growth.
And it looks like we’re currently setting up for that.
Real GDP growth was -1.6% in the first quarter. Thanks to inflation, it’s entirely possible that this number will be negative again for the second quarter. As it takes so long for the numbers to come in, its impossible to know if a recession is happening until it’s already too late.
But for many people, it doesn’t necessarily feel like a recession…
Without looking at GDP growth in the last two quarters or the market, most people’s day-to-day life might not have changed as much as expected in a downturn.
That is because the economy is actually doing quite well.
Employment is strong. Consumer demand is healthy. We haven’t seen widespread credit issues.
In short, we’re only in a “recession” based on its narrow definition (assuming we’re in one at all).
Nominal GDP was 6% last quarter. That’s a GDP metric based on current market prices. It remains strong… and as we already mentioned, employment is healthy as the Federal Reserve raises rates.
We’ve seen a setup like this before.
History may not repeat itself, but it certainly rhymes. We may be following a similar playbook to the 1945 recession.
At the time, real U.S. GDP was negative because the government cut spending as WWII ended.
During the war, we were producing beyond our maximum potential GDP. It was “all hands on deck” for a time, but our production was unsustainable. Said another way, GDP had nowhere to go but down.
The cut in spending simply brought GDP back down to its maximum potential.
Even as soldiers flooded back into the U.S. and started hunting for jobs, unemployment was just 1.9%. Again, this was during a “recession.”
In fact, the market kept on rallying throughout the 1945 recession. The market understood why GDP declined… and what was really happening.
These days, 2022 looks a lot like 1945.
Back then, the country was emerging from WWII. Now, we’re coming out of the COVID-19 pandemic.
Throughout the pandemic, the government threw the kitchen sink at the economy. Between Main Street Lending, Paycheck Protection Program (PPP) loans, and multiple waves of stimulus checks, the powers that be did everything they could to keep the economy humming.
But now, it has been about a year since the stimulus ended. The year-over-year comparisons aren’t looking as good… much like when we wound down production and things returned to normal in 1945.
We’ve already recorded one quarter of negative real GDP growth, and another seems to be looming. Despite this, the economy looks strong. Businesses are recovering. Employment figures are encouraging.
Even during the 1945 recession, the market shrugged off the headline print. Instead, investors focused on fundamentals. It took another year for the market to even blink at what was going on in the economy… and by then, the recession was long over.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research