Tuesday, July 20, 2021
The National Bureau of Economic Research (NBER) announced yesterday that the COVID-19 recession is over. If things don’t feel all that different, it’s because they announced the recession ended in April 2020. Yes, that’s last year. We are now in the 15th month of the new expansion. This delay is perfectly normal. NBER doesn’t change a recession call once it’s made, so they need to have a high degree of confidence in the supporting data. Waiting until 15 months after the recession is over is actually the average since they started making recession calls in real time in the 1970s.
“Stock markets gave us an early signal on the end of the recession back in March 2020,” said LPL Research Chief Market Strategist Ryan Detrick. “The S&P 500 tends to bottom before a recession ends and it did this time as well, despite the narrow window of the shortest recession ever. It just took a while for the economic data to catch up.”
As shown in the LPL Chart of the Day, the recession lasted only two months, the shortest on record, but also one of the steepest, the economy contracting more in just two months than any other recession back to 1948.
So what happens now?
Based on history, we are likely in for several more years of economic expansion. Expansions are on no particular timetable but the average length of an expansion does tell us something about how long it usually takes for the kind of economic excesses to build up that usually cause recessions. While post-World War II expansions have lasted as little as 12 months, the average is more than five years and the last four expansions have averaged over eight years.
Absent an unexpected shock, we would not be on the lookout for a recession until the Federal Reserve (Fed) raises its policy rate several times. Recessions are usually accompanied by an inverted yield curve, where short-term interests are higher than long-term rates, not the normal situation. Since the Fed has a lot of influence over short-term interest rates, they often play some role in the yield curve inverting. The Fed usually won’t start to raise rates until the economy starts to strengthen and will continue to raise rates as it heats up. Raising rates several times is a signal that excesses have started to build that make the economy more vulnerable to a recession. Raising rates also adds to that vulnerability by pushing up short-term borrowing costs.
While rate hike expectations have come forward, they still put a recession several years away. In the Fed policy committee’s latest economic projections, the consensus view was for no rate hikes in 2021 or 2022, and two rate hikes in 2023. While those projections will change based on what’s actually happening in the economy, if it held true it likely would not be enough to signal increased danger of a recession.
But just because we don’t see a recession on the horizon does not mean it’s an all clear for markets. As discussed in our Midyear Outlook 2021: Picking Up Speed, we do still view the overall economic backdrop as supportive. But we are also in the second year of a bull market, which tends to be choppier than the first year, although the S&P 500 Index does typically still see gains.
NBER’s announcement is something to celebrate, but it does not signal smooth sailing ahead. Still, most bear markets are associated with recessions, and with plenty of fiscal stimulus still in play, the Fed’s policy rate still near zero, and the labor market continuing to see strong improvement, even if slower than expected, absent a shock we are not expecting a recession any time soon, and that’s usually good news for markets.
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