The Duration of Economic Downturns: An Examination

The Duration of Economic Recessions

There's often confusion surrounding the specifics of a financial recession and its usual duration. While a recession generally involves two straight quarters of decreasing national output, referred to as GDP, it's more complex than that simple definition suggests. The National Bureau of Economic Research (NBER), which is responsible for tracking recessions, considers a broader range of factors beyond GDP.

Let's delve deeper into what composes a recession, its typical length, and examine some historical examples. We'll also discuss strategies for safeguarding your finances and portfolio during a financial downturn.

What is it?

What is a Recession?

Per the NBER, a recession is described as a "substantial decline in economic activity that extends across various sectors and persists for more than a few months." To meet this definition, a recession must meet certain criteria - depth, diffusion, and duration - albeit in a flexible, interchangeable way. A recession needs to sufficiently touch upon each factor, yet there may be instances where the severity of one aspect can somewhat offset the lack of another. For instance, the swift and widespread economic decline in early 2020, triggered by the COVID-19 pandemic, was classified as a recession despite its brief timing.

To assess economic fluctuations, the NBER monitors various indicators such as:

Real personal income (excluding transfers)
Nonfarm payroll employment
Employment as measured by the household survey
Real personal consumption expenditures
Wholesale-retail sales, accounted for by price changes
Industrial production

The NBER does not follow any set rules to decide the indicators impacting their process or the weight given to these factors when making a recession announcement. However, in recent years, they have given more emphasis to real personal income (excluding transfers) and nonfarm payroll employment.

Causes

What leads to a Recession?

Recessions are often triggered by the following reasons:

Economic overheating: Most recessions stem from an economy that overheats due to higher demand compared to supply. As this demand surpasses full employment and the country's resource capabilities, rising inflation and unemployment below the natural rate (historically ranging between 4.6% and 6.3%) generally ensue.
Financial bubble burst: The rupturing of an asset bubble can cause a recession. For example, the bursting of the "dot.com" stock market bubble resulted in a recession in 2001, while the housing bubble bursting led to a recession in 2007-09.
Economic shock: External shocks to the economy can also precipitate a recession. For instance, oil price shocks in the 1970s and 1980s triggered a recession, and the COVID-19 pandemic sparked a recession in early 2020.

Duration

How long do Recessions last?

According to the NBER, the average recession since 1854 has lasted around 17 months. However, recessions have typically been shorter since World War II, with the typical economic downturn lasting approximately 10 months in the United States. However, recessions can be longer, such as the Great Recession, which spanned 18 months, or exceptionally short, like the COVID-19 recession of 2020, which lasted only two months.

A recession's duration primarily hinges on various factors, including market conditions, the underlying cause, and the response. For example, the underlying cause of the financial crisis (an asset bubble) extended that contraction. On the other hand, the economy recovered rapidly from the COVID-19 shock as it entered the recession in good shape and experienced a swift response from the Federal Reserve Board and Congress.

It's also essential to note that recessions are generally shorter than economic expansions. A typical economic cycle features a prolonged expansionary phase, usually lasting four to five years, followed by a contraction lasting less than 18 months on average.

History

U.S. Recession History

Since the late 1850s, the NBER has cataloged U.S. recessions. Here's a glance at the history of U.S. recessions since the Great Depression:

Preparation

Preparing for a Recession

Though the NBER considers various factors when identifying a recession, real personal income and nonfarm payroll employment carry significant weight. Since most recessions result in a decline in household earnings due to reduced compensation and staffing as businesses adapt to adverse economic conditions, preparing your finances before a recession occurs is crucial.

Some strategies to strengthen your financial situation include:

Building an emergency fund: Adequately saving for an emergency fund can help cushion the blow of financial hardship during a recession. Aim to save three to six months' worth of living expenses.
Reducing debt: Paying down debts, such as credit card balances, can help improve your financial stability during a recession. Increasing monthly payments to your debts can also lead to a reduced interest burden.
Reviewing expenses: Evaluating your spending habits can help identify areas where you can cut back during a recession. Prioritize essential expenses and postpone discretionary expenditures until economic conditions improve.
Diversifying investments: Diversifying your investment portfolio can help manage risk during a recession. Balance your investments between stocks, bonds, and cash holdings to minimize potential losses and maximize returns.
Staying informed: Keep yourself informed about market trends and economic indicators to make informed decisions during a recession. Regularly monitor financial news and consult with a financial advisor for guidance.

Analyze your financial situation: Spend some time to meticulously go over your financial status, covering aspects such as accessible savings, loans, monthly expenditures, and future significant life events. Adjust your spending accordingly to secure more financial flexibility for various purposes.
Enhance your emergency savings: It's crucial to accumulate an emergency fund with at least three to six months' worth of expenses. Set aside more funds to expand your emergency savings.
Emphasize debt repayment. Continue with your debt repayments. If possible, exceed the minimum payments on your credit cards, as this will provide you with more financial flexibility during economic downturns.
Explore career prospects: Recessions can lead to job losses. It's essential to have a contingency plan in place in case you lose your job. Maintain contact with your professional network, upgrade your resume, and explore opportunities to acquire new skills. Additionally, consider taking on extra jobs or starting freelancing to alleviate concerns about job security.

Preparation for a recession ahead of time can help mitigate some of the stress in the event of one causing a drop in income.

Investors' Preparation for a Potential Recession

Investors can also make preparations for a potential recession by adjusting their portfolios. One strategy is to transfer from cyclical stocks to more resilient, recession-resistant stocks. Investors can also enhance their cash holdings by selling less-convincing investments, thereby having more capital to invest in emerging opportunities during a recession.

Stock Market Fundamentals for Novices

For those new to investing, these basics can serve as a helpful guideline.

Is It Prudent to Invest During a Recession?

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Industries That Thrive During Economic Recessions

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What Caused the 1929 Stock Market Crash?

The 1929 stock market crash: Those who ignore history may risk losing their investments during the next major market collapse.

The Closing Thoughts

While there isn't a specific indicator to pinpoint a recession, an economic slowdown typically happens due to an overheated economy, a burst asset bubble, or an external economic shock. They usually last several months, making them challenging periods for consumers.

However, recessions eventually transition into growth phases, which tend to last significantly longer. Preparing for a recession in advance enables you to cope with the short-term challenges while waiting for the eventual market recovery.

FAQ

FAQ on Recessions

Are we currently in a recession?

As of late 2024, the NBER had yet to announce that the U.S. was facing a recession. Concerns about high interest rates intended to combat inflation have adversely affected the real estate market and other rate-sensitive sectors, but haven't impacted the broader economy significantly yet. Employment has remained strong amid weaker job numbers ahead of the elections.

What was the longest recession in history?

The longest recession in U.S. history was the Long Depression, which began in 1873. This series of recessions lasted for more than five years, attributed to the U.S. financial markets struggling to keep up with industrialization and poor monetary policies.

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To further protect your finances during a potential economic downturn, it's wise to invest in recession-resistant stocks. By diversifying your portfolio and carefully analyzing market trends, you can mitigate losses and position yourself for greater returns during a recession.

Additionally, reviewing your financial situation and making necessary adjustments can help provide you with greater financial flexibility in the face of economic volatility. Striving to pay down debt, build an emergency fund, and reduce unnecessary expenses are all prudent strategies to consider for safeguarding your finances during a recession. By being proactive and well-prepared, you can help ensure your financial security even in challenging economic times.