A certain amount of optimism is required in order to look at the path that markets have charted so far this year and not be concerned. (That is, unless you held a massive short on the Dow Jones. Then you'd be thrilled!)
Nevertheless, in spite of the carnage, there are still perma-bulls in the mainstream financial news media that are insisting upon the notion that a recession for the U.S. economy is only a vague or even negligible possibility. This kind of optimism seems naive, but is worth delving into.
What Do We Mean by Recession?
Some of us may find it useful to go over what exactly a recession, a correction, and a bear market are.
A correction is the least severe of the three scenarios. This merely means a market (or an individual stock, or sector) has lost 10% of its value from its one-year high price point. Market corrections happen fairly frequently, and are called "corrections" for a reason: They are not seen as dire, trend-defining movements. Corrections are, for lack of a better comparison, exactly what they sound like. They represent a pullback toward more appropriate asset values following a period of inflated prices.
Next is a bear market. This is when a market (or, again, a sector, a security, etc.) is trading at least 20% below its 52-week high. We usually associate bear markets with significant shifts in trend direction. While it may seem that most of the damage has already occurred if a market declines by 20% in such a relatively short period of time, the onset of bear markets (which alternate with bull markets) are generally cyclical, and stay in place for years to come.
Finally, there is a recession. This is simply two consecutive quarters of economic contraction. In other words, an economy must shrink in back-to-back quarters (3-month periods) for the onset of a recession to become official. Individual economies can fall into a recession, just as the global economy as a whole can enter a recession. The only real difference between a recession and a depression is the length of time they last and their severity. (For this reason, economists generally view a "depression" as fundamentally threatening the economic system, while recessions are more "natural" downturns in typical business cycles.)
The beginning point of a recession is rather straightforward—but when does a recession end? That's a far trickier question. Some would say it's whenever the contraction ends; others contend it's when growth begins again. Still others may suggest that stagnation is part of the process, so a recession hasn't truly ended (i.e. recovery achieved) until consecutive periods of growth can be strung together. In any case, a recession is typically measured by gross domestic product (GDP) and real economic activity, not simply by stock market performance.
Don't Worry, They Told Us
With this notion (of recession being measured in GDP, not stock index values) in mind, it seems counterintuitive that Bloomberg Business recently touted that there is no reason to worry about a U.S. recession. Its case relies upon certain stock market indicators as a way of predicting future performance based on the past. Although there are definitely some correlations and relationships between U.S. stocks and the U.S. economy, they are hardly one and the same.
Unfortunately, this sort of faulty reasoning bleeds into the public psyche. Steven Schwarzman, the CEO of Blackrock Group, the world's largest alternative asset manager, summed it up well: "At a certain point the markets become reality if they affect the behavior of regular people." If we see this kind of "monkey see, monkey do" logic take hold, it may well defy the historical precedents cited by Bloomberg and plunge the real U.S. economy into recession.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.