Whenever the economy shows any signs of slowing down the word recession is inevitably and frequently used in the media. But sadly, most people do not know the real definition of recession. It shows up regularly in coverage of politics, major breaking news, economic news and of course business and market news, making recession an important topic for us to properly address. It is one of those words in English that doesn’t have a particularly nice ring to it. Neither does bogeyman. Both are pretty ugly, but the bogeyman only brings fear to the hearts of young children because they don’t understand that there is no bogeyman. That is not to say that recession does not exist but, understanding the true definition of recession can certainly help allay some of the fear.
So, what is the TRUE definition of recession?
Like so many other terms and usage in market discussion, the tremendous amount of commentary on the subject has lead to the definition of recession being misinterpreted, distorted, confused, or lost.
There is a technical indicator of recession and it is not a finance or investment one. It comes to us from economics. Simply put,the definition of recession is two consecutive quarters of decline in a country’s gross domestic product (GDP). In other words, six consecutive months of negative economic growth means a country is in a recession. To review, Gross Domestic Product is the single most important leading indicator for you to be familiar with. GDP is calculated on a quarterly basis, reporting on the aggregated monetary value of all goods and services produced by the entire economy during a three month period. Investors should be concerned with following changes in the GDP. Historically, our economy has grown at an annual rate of about 2.75%. Deviations from the norm can have significant impact. Growth of the GDP at rates higher than the norm may seem like a good thing, but it is generally referred to as an overheated economy. This is because rapid growth is usually unsustainable and is a precursor to high rates of inflation. Growth of the GDP at rates below the norm means the economy is sluggish and can lead to lower spending, decreased confidence, and increases in unemployment.
In the field of investment, where timing is all-important, recession, according to its true technical meaning, covers a long time line. The investor can’t wait for six months of economic decline and perhaps one or two additional months gathering the data before a recession is actually declared. Hence comes the confusion.
Why isn’t recession readily identifiable?
Unlike the economist, for the investor, there is no strict definition for recession. There are usually signs of recession-like behavior in the economy and these do not go unnoticed. It is best to filter out this speculative media concern.
Different people consider different factors in making their assessment of recession, so we must remain cognizant of the fact that a slew of people are doing their analysis and some of them could be talking recession and taking recessionary measures when, according to your personal view, there really isn’t anything seriously wrong with the economy. Recession can become a psychological fabrication and herein lies the danger, because the actions of negative investors can indirectly impact you and your investments. It is well known that, the “man-on-the-street” who posses a very bullish sentiment when the market has been nosing upward for six straight months, can easily come up with a host of reasons why he shouldn’t invest when the market has been down for six months.
The facts(?) indicating depression.
But, what about the facts pointing to actual recession and not the psychology of it? The state of the US economy at the end of January, 2008 is an excellent example of the confusion surrounding hard facts. Examine the January news stories and you get CNN MarketWire leading with “Top Wall Street Economists: US may already be in a recession”, the key word here is may, BBC News, Business, quoting Merrill Lynch with “Recession in the US has arrived”, and Business Week reporting, “No recession but most experts we polled expect meager growth”. If all those experts can’t decide, then what do you know, right? And your neighbor next door, is he right? And the cab driver who takes you to the airport for your recessionary get away to the winter sun, is he right?
So, it is not so much a question of worrying about being in a recession as it is to recognize the signs of an approaching one. And, what to do about it. Right here would be a good time to remind readers to review an earlier article on stocktrades.ca explaining leading economic indicators. It deals with some of the important signs and information you can glean from various ongoing measures of economic activity.
Economies are a big, big machine and there is not much the individual investor can due to alter an economies course away from adjustment, decline, technical recession, extended recession, deep recession, or the real bogeyman of economic woes– depression. Insight into the health, direction and potential of a country’s economy is an essential for the investor to include in his decision making process.
One thing is for sure in recessionary times. Business activity slows, employment falls, retail sales drop off and therefore industrial production decreases.
Recessions are a natural part of a nation’s economic cycle. An over heated or growing economy needs a period of recession in order to stabilize and revitalize. The old saying of what goes up must come down is true, but remember the market bounces when it hits the ground. Count on that.
Positioning your investments to deal with recession.
No matter the reason for a decline in the market – recession real or imagined – there are a few things wise investors can do to continue making money while awaiting recovery.
Here are some guidelines to follow:
Try “Value Investing”. Look for bargain priced stocks that may be undervalued due to slowing in market activity. Value stocks are always out there to be found during recession and remember, some of the most famous investors have acquired their wealth in this way. Search for well established companies that have been positioned to make it through previous recessions. Historically, these companies are characterized by slow, regular growth. Coca-Cola comes to mind. The best buy among those companies on your list will be those furthest away from their 52 week high.
Look for companies with lots of cash on their balance sheets. Under normal conditions, management hoarding too much cash could be a symptom of not using liquidity to their companies advantage, but during recession cash is essential for riding out periods of slow sales. Apple Computer, for example is sitting on $15 billion of cash in the bank. That is enough to carry on with normal research and development, setting Apple up to come out of a recessionary period with an arsenal of innovative ideas lined up for consumers anxious to resume spending.
Think about companies that are in recession proof industry sectors. People always need to eat. Choose under priced stocks of companies supplying a needed service or product.
During recession, consumers always put off laying out large amounts of cash for big ticket and luxury items. They are content with accessorizing what they own, so your job is to find companies specializing in after market, add-on components. Keep an eye on companies selling big ticket items usually companies in these sectors are hit first and hit hardest. If you hold these stocks, get rid of them early and buy back in later when you think they have bottomed out and you will be better positioned to reap the benefit of the recovering economy.
Take a more conservative route if you must. Consider moving money into the bond market to sit out the storm.
No matter the approach, the most important point of this article is to stress the importance of tuning out the negative talk in the media so you as an individual investor can concentrate clearly upon alternative action. It is sad but true that the impact of recession is multiplied greatly by the psychology of fear. The actual economic impact of a simple adjustment in the business cycle or economic cycle, can more often than not, snow ball into a completely unwarranted recession.
Pulling out of recession. How does an economy recover from recession?
There are several schools of economic thought that try to adequately address that question. It can be Keynesian Economic Theory, government fiscal policy, central banking system intervention, or just laissez-faire liberalism which allows natural forces to run their course. These are all complete, separate, stand alone independent studies which are not the target of this particular look at recession. To keep it simple the underlying solution to pulling out of recession can be summed up in one word. Spend.