This week, the Bureau of Economic Analysis (BEA) announced the US economy (GDP) contracted 0.6% during the second quarter of 2022 (2Q). 2Q GDP. This was the second consecutive quarter of economic contraction, as least as defined by the BEA’s GDP equation (C+I+G +/- NE). Historically, this has been the unofficial definition of the dreaded word recession.
However, the truth is a little more nuanced than that. When it comes to this stuff, it always seems to be.
The official arbiter of recessions is the National Bureau of Economic Research (NBER). If you aren’t familiar with this group, you aren’t alone. This group’s work isn’t normal cocktail party conversation. The NBER doesn’t make the headlines very often, and its social media posts are dry as dust. Basically, it is a group of academics doing work for academics.
Still, it decides what a recession is and when it occurs.
Would you care to take a guess as to how the NBER defines a recession? Although folks throw around the two consecutives of contraction as economic gospel, this definition is from the organization’s website:
“The NBER’s traditional definition of a recession is that it is a significant decline in economic activity that is spread across the economy and that lasts more than a few months. The committee’s view is that while each of the three criteria—depth, diffusion, and duration—needs to be met individually to some degree, extreme conditions revealed by one criterion may partially offset weaker indications from another.”
So, if that is the NBER’s litmus test, if you can call it that, are we in a recession? My answer will make absolutely no one happy: “it depends on where you look.” Some sections of the economy have seen a sharp contraction in economic activity. Shoot, talk to residential real estate developers about that. Conversely, other sectors have barely hit a speed bump.
As a result, I don’t believe the NBER will be in a hurry to declare the first two quarters of 2022 a recession. While there have been pockets of pain, there hasn’t been a “significant decline in economic activity that is spread across the country.” The operative words here are significant and across.
How can I possibly say or write that?
If you click on these two links here and here and scroll down to Table 2, the devil is in the details. You see, last quarter, a decrease in the rate of growth in inventories (line 40) took 2.01% off the equation. The phrasing of that sentence is important: a decrease in the rate of growth. You see, businesses ‘only’ added an annual equivalent of $81.6 billion to inventories last quarter. In 1Q, they added $188.5 billion. Still growing, but at a lower level.
If this seems bizarre, it is just the way the equation works.
Essentially, IF you back out this line item, the rest of the economy grew at a 1.1% clip. While that is nothing to cheer about, it isn’t contraction. Further, in 1Q, a surge in our imports, in order to grow our inventories by $188.5 billion, shed a whopping 3.23% off the equation. If you take that out, GDP increased at a 1.4% rate.
In so many ways, the way the equation works is arguably worse than reality. To be sure, again, some sections of the economy have had a difficult time thus far in 2022. However, going back to those two words, significant and across, it is very difficult to say the entire economy is in recession.
Shoot, if I can remove line 40 in Table 2 in 2Q and 43 in 1Q and magically get to growth, it is difficult to imagine the NBER calling the last two quarters of sluggishness a recession.
Of course, stranger things have happened….and might still. Further, a stronger recession might be still be lurking in the future. One for which there is no ambiguity. But is this likely?
As I type on July 27, 2022, the following things appear possible, if not probable. First, inflation will start to fall with the next reading of the Consumer Price Index. This doesn’t mean inflation won’t be higher than anyone would like. It will be. It just means it will start to increase at a decreasing rate. Second, if this is the case, the Federal Reserve won’t have to be as aggressive as many originally feared. Essentially, it won’t have to kill the economy in order to kill inflation, a la Paul Volcker.
Third, although the economic headwinds won’t be as strong as we thought, the tailwinds won’t be either. This will lead to a sort of ennui, if you will, for the back half of the year. Things won’t be awful, but they will be far from awesome. Fourth, believe it or not, this will be welcome news for the stock markets, which have priced in a worst case scenario. As a result, patient investors will be able to sop up much of the red ink from the first two quarters.
Fifth, and finally, at some point in the future, the NBER will likely look back on 2022 and declare a recession occurred. While it might have been (or will be) a kilometer wide and 6 inches deep, it will say one happened nonetheless. Such as it is with the economy and economists.
In the end, as strange as it may sound, the economy has contracted for two straight quarters, and we might not be in an official recession. That doesn’t mean things are humming along as smoothly as last year. Far from it. However, the whole thing doesn’t seem to be completely falling apart.
In a world where all news is bad news, that sort of mediocre forecast is actually great news. What’s more, I think most people would take it as such.
Thank you for your continued support, and indulging me. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows not only on this day but on every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
Chief Economist & Pragmatist
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as those of our investment committee Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.