Marshall Commentary

We understand that financial planning isn’t always top of mind – but it is for us! Each month we publish a commentary to update you on the latest financial trends and changes.

Wealth IQ – July 2022

by Adam Reinert, George Evans II, & Sean Dann | July 21, 2022 | Commentary

Marshall Wealth IQ is aimed at sharing insightful financial market and economic data in easy to visualize charts with brief analyses. This commentary isn’t designed as a call to investment action, but rather as a dependable source to help you feel better informed about current events in today’s market and the underlying trends impacting current wealth.

As the Federal Reserve tightens monetary policy, there has been renewed concern about recession risk. This Wealth IQ explores what constitutes a recession, discusses who decides if a recession has occurred, examines the current business cycle, and sheds some light on whether the prospect of recession is more concerning than a recession itself for financial markets.

Let’s get started:

1) The first half of 2022 has been everything the prior 18 months were not. Speculators who had been rewarded with intoxicating returns felt heavy and sudden losses as the easy money and low rates that drove the post-COVID market quickly vanished. Now, with markets down, inflation continuing to hit new highs, and consumer confidence sinking, many are ringing recession alarm bells. Looking at our business cycle checklist, while we don’t meet the marks of a full-blown recession just yet, there are signs economic activity is slowing, with the risk of eventually hitting recession territory. Although this term is thrown around in an apocalyptic way in financial media, its true definition and purpose in the business cycle is much more nuanced and is far from a harbinger for the end of the economic world.

Data Source: Blomberg LP, YCharts
2) The group charged with declaring a recession in the United States is the National Bureau of Economic Research (NBER). This organization monitors economic indicators and determines the peak and trough of each US business cycle, with the period between the peak of a business cycle and its subsequent trough being known as a recession. Importantly, recessions are declared with a significant lag, both due to the time it takes for economic data to be published as well as the fact that a downturn must be sustained for it to be considered a recession. Our most recent recession, an end of February 2020 cycle peak to an end of April 2020 cycle trough (the shortest recession in US history), was not declared a recession until June 2020. A series of indicators NBER consults when dating recessions can be seen below.
Source: Bloomberg, L.P.
3) NBER broadly defines a recession as “a significant decline in economic activity that is spread across the economy and lasts more than a few months.” A more colloquial definition often referenced is “two straight quarters of negative GDP;” however, this is nothing more than a non-binding rule of thumb. In fact, there is no quick and easy way to define a recession – it is ultimately up to NBER to decide based on their list of quantitative and qualitative economic indicators. Below are charts of US GDP and the S&P 500 (log scale) since 1950, with recessionary periods highlighted in gray. As seen in the last two recessions (2008-09 and 2020), both GDP and the S&P fell sharply for a period before regaining their upward trend shortly thereafter.
Data Source: National Bureau of Economic Research, YCharts
Data Source: National Bureau of Economic Research, YCharts
4) While there are several ways that an economy can enter a recession, they generally occur when some part of the economy has fallen out of equilibrium. The 2020 recession was brought on by an exogenous shock in the form of a global pandemic. As the global economy grinded to a halt almost overnight, millions were laid off, businesses shut down, and economic activity around the world was suffocated. The Great Recession of 2008-2009 was brought on more endogenously as unworthy borrowers began defaulting on their hefty obligations. Financial institutions were stressed, and economic activity quickly dried up. Whether endogenous or exogenous, the form in which recessions are brought on come in many shapes and sizes and is the reason why they are often so hard to predict far ahead of time.
Data Source: National Bureau of Economic Research, Investopedia
5) When we get sick, the steps we take to regain our health (rest, medicine, etc.) are based on the illness we are dealing with. The economy is no different – when it falls out of equilibrium, we take steps to “get back on track” based on what has caused the disequilibrium. In 2020, in response to the economy pausing overnight, we quickly injected liquidity and dropped interest rates to effectively zero in an effort to kickstart business activity. In the Great Recession, we shored up the rules and regulations that allowed the crisis to happen and worked to spur new economic activity. The United States holds many fiscal and monetary tools that it can use based on the specific type of recession it is encountering.
Data Source: Bureau of Labor Statistics, International Monetary Fund, Congress.gov, Investopedia
Data Source: Bureau of Labor Statistics, International Monetary Fund, Congress.gov, Investopedia
6) Despite its intimidating connotation, a recession is a natural and healthy feature of a free market economy. The same freedom of economic activity that allows for innovation, wealth creation, and growth, also allows for excess, mistakes, and economic shocks. Most often, a recession is either the direct result of one of these negative features or a necessary part of the process for correcting them. Undergoing this process to get the economy back on solid ground is what allows us to create a new base and hit new highs in the future. We have yet to see a recession in the United States that has not eventually led to higher levels of economic output, increased stock market levels, and further innovation. As seen in the table below of the 10 most recent US recessions, both in time and magnitude, the good that occurs outside of the necessary evil of a recession is well worth it.
Data Source: National Bureau of Economic Research, YCharts
Data Source: National Bureau of Economic Research, YCharts
7) While the post-COVID economy and business earnings have remained strong, caution signs have begun to flash as inflation and employment run dangerously hot. With inflation at a staggering 9.1% (far above its equilibrium of ~2%) and an unemployment rate of 3.6% (far below its equilibrium of ~4-5%), the economy faces the potential risk of long-term inflation expectations becoming unanchored. To combat this, the Federal Reserve has been aggressively hiking the Federal Funds Rate, making borrowing and investment more expensive. While this is a prudent move to bring inflation back in line with long run expectations, it comes with the cost of pulling down economic activity. With this comes lower business earnings, and likely, a recession. Popular leading economic indicators such as Consumer Expectations, New Manufacturing Orders, and the Stock Price Index have materially declined in recent months.
Data Source: Bloomberg LP, Conference Board
Data Source: Bloomberg LP, Conference Board
Data Source: Bloomberg LP, Conference Board
8) However, not everyone has resigned themselves to the fact that a recession is inevitable. Part of the inflation story is still attributable to supply-side issues and geopolitical conflict (both of which are immune from Fed influence). Should those problems correct themselves, we may see some inflation relief without the need for severe demand destruction. At the same time, at least some level of demand destruction will likely be necessary, no matter what happens in those two areas. The question is how much will demand need to be pulled down before inflation is brought back in check. The answer to this question will decide if we enter a recession, and if we do, how long/severe it becomes. As seen below, many supply-side pressures are showing signs of easing.
Data Source: MacroTrends, Redfin, FRED (St. Louis Fed), Pantheon Macroeconomics
Data Source: MacroTrends, Redfin, FRED (St. Louis Fed), Pantheon Macroeconomics
Data Source: MacroTrends, Redfin, FRED (St. Louis Fed), Pantheon Macroeconomics
9) Fortunately, even if we do enter a recession, we are not likely to feel the immense pain levied by the most recent two in 2008-09 and 2020, which each had features not experienced since the Great Depression. The Great Financial Crisis was exacerbated by massive structural issues and overextended debtors, while the COVID pandemic saw the quickest meltdown of economic activity in modern history. Today, in 2022, the backdrop is far different. Businesses and consumers have strong balance sheets, and for now, broad earnings have yet to completely roll over. Valuations have come back in line with historical averages, and the main issue plaguing the economy has been well identified. While a recession is never ideal, if there was an economy well equipped to handle one, it would likely look a lot like the one we are in today.
Data Source: FRED (St. Louis Fed), Pantheon Macroeconomics
Data Source: FRED (St. Louis Fed), Pantheon Macroeconomics

It’s impossible for anyone to know with certainty what will happen today, tomorrow, or even a minute from now. Investment involves risk and volatility; it’s why long-term investors have historically been rewarded with excess returns relative to cash. Our investment department monitors market data and works with our wealth advisory teams to right-size portfolios should something change relative to long-term trends. In the meantime, we’ll continue to share financial and economic data we believe is insightful and relevant to your wealth to help you feel informed.

Thank you for reading; please be well and stay healthy.

Adam Reinert, CFA, CFP®

Chief Investment Officer

George Evans II, MBA

Chief Investment Strategist 

Sean Dann

Research Analyst

Disclosure:

Marshall Financial Group, Inc (“Marshall Financial”) is an SEC-registered investment adviser with its principal place of business in Doylestown, Pennsylvania.   This newsletter is limited to the dissemination of general information pertaining to Marshall Financial Group’s investment advisory services.  Investing involves risk, including risk of loss.  References to market indices are included for informational purposes only as it is not possible to directly invest in an index. The historical performance results of an index do not reflect the deduction of transaction, custodial, and management fees, which would decrease performance results. It should not be assumed that your account performance or the volatility of any securities held in your account will correspond directly to any comparative benchmark index.

This newsletter contains certain forward‐looking statements (which may be signaled by words such as “believe,” “expect” or “anticipate”) which indicate future possibilities. Due to known and unknown risks, other uncertainties and factors, actual results may differ materially from the expectations portrayed in such forward‐looking statements. As such, there is no guarantee that the views and opinions expressed in this letter will come to pass. Additionally, this newsletter contains information derived from third party sources. Although we believe these sources to be reliable, we make no representations as to the accuracy of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility, therefore.

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