The Recession is Coming! The Recession is Coming! What is a Recession Anyway?

One of our least favorite things about investing is the remarkable imprecision of language. There are so many terms like “risk,” “momentum,” “smart beta”, and “asset class” (among many others) that have no precise definition– and yet, everyone assumes they know what those terms mean.

We were thinking about this recurrent complaint while being barraged with articles and narratives about the inevitable coming “recession.” While we don’t want to seem callous, our concern is with the effect of a “recession” on portfolio returns, not the actual economic effects. Assuming the next “recession” is more of the garden variety and not like 2008, what would the impact be on the equity market?

Of course, the term “recession” does have a specific definition. The only problem is that it’s arbitrary, utterly useless to investors, and NOT the one you think it is. 99% of professional investors think the official definition is two consecutive negative quarters of real GDP as established by the National Bureau of Economic Research. Wrong! Here’s the official definition: “The NBER does not define a recession in terms of two consecutive quarters of decline in real GDP. Rather, a recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”

This is actually much more sensible than the conventional wisdom. Think about it—What if there were one quarter of negative 10 percent growth, and then a quick rebound? That would sure feel like a recession. How about a year with the following sequence of GDP quarters- -3,+1,-3,+1? No recession there either, but that’s also not going to make anyone happy. Alternatively, you could have a year that was -.1,-.1, +4,+4 that is a recession by conventional wisdom but would be the highest growth rate in recent memory. In fact, the NBER says that the U.S. economy was in recession for 8 months in 2001, and yet there were NOT two consecutive quarters of negative GDP growth.

Regardless of how you define them, recessions are by no means homogeneous and will have radically different effects on both the economy and markets. For instance, the 2001 recession was largely in the bubble sectors of technology and telecom and had very little long-term impact on the economy. On the other hand, the 2008 Great Recession still has aftershocks that we are feeling today.