Not since Bill Clinton testified about the meaning of the word “is” has so much hinged on the meaning of one simple word.
The word is “recession,” and defining one isn’t easy. It’s usually up to the National Bureau of Economic Research to determine when one has started, but it often takes so long that the slowdown is over by the time one is declared. Others point to the technical definition of two consecutive quarters of declining economic growth—something that could be declared as soon as this coming Thursday, when second-quarter gross domestic product is released. (The Atlanta Fed’s GDP Now tool is indicating a potential contraction of 1.6%, the same as in the first quarter.)
This isn’t merely semantics. The Dow Jones Industrial Average rose 2% this past week, while the S&P 500 was up 2.6% and the Nasdaq Composite notched a 3.3% gain. Whether or not we’re in a recession, have already had one, or are heading into one isn’t irrelevant when trying to interpret the stock market’s gains.
If the technical definition of two consecutive down quarters is correct, then the economy is probably in a recession—and it may be almost over. If that’s the case, then it could be argued that the S&P 500’s 24% drop from its January peak through its June low was the stock market reflecting the slowdown—and the bottom wasn’t just a bottom, but the bottom. Optimists could—and will—argue that the index’s 8% rally since the June low is the start of a new bull market.
But the two-quarter rule might fall short in this case. Larry Adam, chief investment officer at Raymond James’ private client group, notes that the first quarter’s decline was driven by a massive amount of imports relative to exports, while the second quarter’s decline—if, in fact, there was one—will have been driven not by a lack of business activity but a drawdown of inventories. “Even if the 2Q GDP is negative, it is premature to say the U.S. economy is in a recession,” Adam writes.
There can be no doubt that the economy is weakening, perhaps to a worrisome extent. This past Friday, we learned that the Markit Composite Purchasing Managers Index, which accounts for both services and manufacturing, fell to 47.5, below the 50 level that separates growth from contraction. The Conference Board’s leading indicators also turned negative, while jobless claims continue to rise.
“If you have a monetary-policy-driven road to recession, it happens slowly, then suddenly,” says Dave Donabedian, chief investment officer at CIBC Private Wealth US.
It’s now up to the Federal Reserve to determine where the economy goes next, says John Silvia, who writes the Dynamic Economic Strategy newsletter. On one hand, the Fed could decide to keep fighting inflation until its target is reached, leading to a recession that lasts four quarters or more. It could also decide enough is enough, in which case the economy keeps growing, but inflation gets stuck around 4% to 5%. “[It’s a] very complex give/take process with no simple linear solutions,” Silva says.
Don’t expect the stock market to go in a straight line either.
Write to Ben Levisohn at Ben.Levisohn@barrons.com