Lately there has been a lot of news coverage about the possibility we’re in a recession. Some economists say we’re in a recession. Some say we’re not quite in a recession, but we’re close. Others think the economy is humming along just fine.
You might wonder:
“Why is there uncertainty over whether we’re in a recession? Shouldn’t the economists simply look at the numbers and reach a conclusion?”
Unfortunately it’s not that easy. There is no universally agreed definition of “recession.” A commonly used definition is two or more consecutive quarters of decline in Gross Domestic Product, or GDP. The National Bureau of Economics Research uses a different, more complicated definition. I imagine there are as many definitions as economists.
I am not an economist, but I would hazard a guess that all definitions suffer from the same problem: we can’t detect a recession until many months after it begins. Many recessions are over before we realize they began!
For example, let’s suppose we’re in a recession right now. How soon would we know? Under the “two consecutive quarters of GDP decline” definition, we would need to see both the first and second quarter GDP numbers. It takes about three months to see final GDP results after the end of a quarter. It would be September by the time we see the final second quarter GDP numbers. Even if we’re in a recession now, we wouldn’t know it until the last few months of the year!
Forward-Looking vs. Backward-Looking
Recessions are backward-looking. Stock prices, on the other hand, are forward-looking. Stock prices are largely based on the expectations of future earnings. Stock prices represent investors’ best estimates of future earnings.
It doesn’t make much sense to use a backward-looking indicator to make forward-looking decisions. You have to make investing decisions with the information you have available. You can’t wait six months to gather data before making today’s decisions.
What does this mean for investors? It means this:
Don’t pay undue attention to what the economists or politicians say about whether we’re in a recession. The market doesn’t much care whether the economy meets a formal definition of recession. Even if it did, we wouldn’t know until long after the time for decisionmaking has passed.
A Rose by Any Other Name
“Recession” is just a word. There is not a universal definition. The various definitions have a healthy dose of arbitrariness. There’s nothing magical about two consecutive quarters of GDP decline. Why not six months? Why not three quarters? Why not look at corporate earnings? Why not use stock prices?
To me, it doesn’t make much sense to use backward-looking, arbitrary definitions to make investing decisions.
What You Should Be Doing
What is the wise money decision at a time like this? Whether we’re in a recession or not, continue to invest as you always have. Don’t make any fundamental changes to your strategy simply because economists say we may be in a recession. The word “recession” is for economists, not investors.
If you insist on making a change to your strategy, all else being equal you should choose to invest more, not less. To the extent other investors flee the market for fear of recession, you will be able to buy at attractive prices. Continue to stockpile the stocks and funds that will be the source of your future financial freedom.
P.S. Just in case you were wondering, “arbitrariness” is a word. “Decisionmaking” is not.