Question

Is the U.S. economy in a recession or not? Check the "official" opinion at the National Bureau of Economic Research (NBER) at www.nber.org/data (Links to an external site.) Link to the official Business Cycle Dates. How does NBER select the beginning or end of a recession? What period in U.S. economic history was the longest expansion? Contraction? Look at the Announcements Dates section toward the bottom of the page. How much of a time lag is there between when a peak or a trough occurs and when it is announced? What implication does this have for investors?

Answer 1

As one common definition of a recession is negative economic growth for at least two consecutive fiscal quarters, some analysts suggested this indicates that the U.S. economy was not in a recession at the time.The introductory statement is actually too harsh, but it is true that the NBER process does not have strict mathematical definitions. And the lead certainly is good attention grabbing journalism.

The dating process is made by a “weighing and sifting” process and a best judgment call is made as to what are the starting and ending months for any recession. The people involved in the process are not hacks; they are among the brightest and best trained macroeconomists we have. It is unfortunate for them that macroeconomics in general is in such disarray today. However, the disarray of the field in general does not detract from the regard that I hold these “recession hunters”. With that introduction, let’s examine some details.

The start and end dates of recessions are fixed by the NBER (National Bureau of Economic Research). A committee of economists examines a broad range of economic factors to determine when the preponderance of evidence indicates that a peak in economic activity has been passed (the start of a recession) and when a trough is indicated by a preponderance of the factors (the end of a recession). A quote from the NBER dating procedure document (here) explains the process and emphasizes that there is some degree of flexibility in the determination of start and end dates:

The committee places particular emphasis on two monthly measures of activity across the entire economy:

(1) personal income less transfer payments, in real terms

(2) employment. In addition, the committee refers to two indicators with coverage primarily of manufacturing and goods

(3) industrial production

(4) the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes.

The committee also looks at monthly estimates of real GDP such as those prepared by Macroeconomic Advisers. Although these indicators are the most important measures considered by the NBER in developing its business cycle chronology, there is no fixed rule about which other measures contribute information to the process.

Following a mild recession that ended in 1991, the U.S. entered into its longest period of economic expansion, lasting exactly 10 years.

• Recessions were common from 1865 to 1917, with 338 months of contraction and
  382 months of expansion [compared to 518 months of expansion and 96 months of contraction from 1945 to 1996]
• The longest contraction on record was 65 months, from October 1873 to March 1879
• The worst economic contraction was the Great Depression of the 1930s

As a result, the dates of the peaks and troughs are not typically announced until six months to a year after they occur.

The Effects of Recession on the Stock Market

With the intense focus on the stock market, it can be easy to forget that the market is one component of the economy; it's not the economy itself. It represents numerous economic players and entities, such as companies and pools of capital. A recession affects the companies whose shares make up the stock market, and it affects the people who invest in those companies' stocks. Psychology is as important as tangible effects.

Recession Hurts the Economy, Hurting Companies

A recession is a slowdown or halt to the economic growth of the country. This can lead to unemployment and lower spending by individuals and companies. All the factors in a recession are intertwined. For instance, unemployment is likely to increase as companies try to boost their margins -- when people spend less because of the increase in unemployment. The factors feed into one another in a declining spiral. Companies suffer from lower revenues, lower profits, and weaker growth in the future. All those factors come into play to determine the value of a stock on a fundamental level. As the companies' business suffers, so too does their stock price, leading the whole stock market lower.

Economic Malaise Erodes Investor Confidence

Even if a company is weathering the storm of a recession well, investors might not trust this to continue. Investors also might not trust the overall market, because the entire market tends to have a general trend, although a single stock might run counter to the trend because of exceptional circumstances. When the whole stock market is declining, individual stocks decline as well. It might be considered prudent to then move to a cash position and liquidate all investments. A resulting large-scale shift of money out of stocks can cause further stock market declines. The perception of a weak market can reinforce a weak market.

Financial Need Can Result in a Flight of Capital

The largest players in the market are institutions that might have capital pooled from numerous individuals. As a recession carries on, people might pull money out of the market to meet basic needs, especially if they are unemployed. Without a job, investment capital can quickly become savings. Fiscally conservative investors who lose faith in the stock market as a viable investment might abandon stock market investing. This is different than the temporary move to cash that can result from the expectation that the stock market will continue to decline for a while.

Spurring Government Action

Government stimulus packages and actions by the Federal Reserve Board can have an effect on the stock market during a recession. Federal stimulus programs can attempt to reverse the recession, although they might merely prevent it from worsening. A stimulus can help the market by giving an infusion of cash to individuals, local governments, and certain companies. On a wider scale, the Federal Reserve can institute bond buying to infuse capital into the economy to get money flowing. This can inflate stock prices while a recession is still raging. An example of this would be the boost the stock market got from "quantitative easing" -- the Fed's buying up of mortgage-backed securities to increase the money supply.