There has been alot of talk of a recession in 2023, as if it is just a given that it will occur. However, this is not necessarily the case, and there are many differing opinions on the subject by various economists ranging from PIMCO, which believes we will most likely have a recession, to Goldman Sachs (GS, Financial), which believes we definitely won’t. There are also various opinions on if a recession will be “long” or “short” if one happens.
In this article, we will dive into what exactly makes a recession, what history can tell us about previous recessions and several prominet economic forecasts for 2023 from reputable analysts.
What is the offical definition of a recession?
Many people use the word recession without truly understanding what it means. It's a common misconception that an economic decline or a worsening cost of living situation equates to a recession. The technical dictionary definition of a recession is when Gross Domestic Product (GDP) falls for two consecutive quarters. When this happens, the economy isn’t growing but in fact shrinking. Breaking this down further, GDP is the total value of all products and services sold within a country. This includes private consumers, private investment, government investment and spending. This means that even if the economy is worsening, things like high inflation, rising debt and money printing can mean GDP is still growing, thus there is technically no recession.
Billionaire investor Ray Dalio (Trades, Portfolio) of Bridgwater Associates likes to refer to the economy as a “machine." When you purchase a product/service, you are indirectly providing income to the entire pipeline that led to the provision of that product/service. If one person's spending reduces, then that will likely have a knock on effect to the next person and so on.
Of course, there are other definitions of a recession as well. According to NBER, for example, a recession can include a decline in “GDP, real income, retail sales, industrial production and employment."
How often do recessions occur?
The economy has a tendency to move in “cycles” and a recession has occurred once every five to 10 years on average in the U.S. based on historical data.
Recessions have historically lasted an average of 11 months but this does vary based on the severity and fiscal response. For example, the financial crisis ran between December 2007 and June 2009, lasting 18 months. While the 1980/1982 recession lasted ~16 months.
Why do some economists think we will have a recession in 2023?
According to a probability model from The Conference Board, the U.S. has a 99% chance of a recession starting in early 2023. This is one of the more extreme projections, but The Conference Board isn't alone in thinking a recession is almost guaranteed this year.
To recap, the economy was humming along nicely until the Covid-19 crash of 2020. This resulted in many parts of the economy (from travel to hospitality) being effectively shut down for many months and even up to a year in some cases. In any normal scenario, this would have caused extensive job losses and a devastating impact on the economy. However, the impact was short-lived as central banks from around the world flexed their powers with significant cash stimulus in the trillions of dollars range. Globally, there was about ~$847 billion in stimulus checks provided directly to citizens, as well as various business grants, bailouts, bond buying schemes, etc.
A positive is this actually solved the issues in the short-term (read: delayed them for a later date) and resulted in not just a positive outcome but tremendous exuberance in the stock market. However, nothing in life is free, and these strong economic measures resulted in high inflation. Inflation measured by the CPI peaked at 9.1% in June 2022 for the U.S., which is substantially above the Federal Reserve's 2% target.
High inflation by itself can act as a catalyst for a recession if the prices of essential goods are rising faster than income. To combat this, the Fed has used its main tool (raising interest rates) to try and tame inflation. The idea is to slow down an overheating economy. So far, the plan has been working somewhat as inflation has fallen to ~6% as of February 2023.
However, the economy has become too dependent on low interest rates. We've built all our financial models assuming cheap debt. Raising interest rates also comes with the cost of increasing mortgage expenses for homeowners in an underbuilt market. Normally, home prices should adjust down for higher mortgage rates, but underbuilding and a glut of investors is preventing this. Businesses also cannot use their strategy of paying off their existing debt with even more, cheaper debt. The end result is less income for the average person and lower profits, investment and growth for businesses.
The economy is also impacted by “expected inflation” because if businesses think their input prices will go up, they often raise prices beforehand, effectively causing inflation to worsen.
Then, why are some saying we won't have a recession? One of the top reasons is likely high savings rates from stimulus checks and money printing, but that will eventually be chipped away to nothing as inflation continues soaring.
Will we have a long or short recession?
Whether we have a long or short recession may depend upon how long the Fed plans to keep interest rates elevated. 58% of the 48 economists surveyed by NABE, forecast a recession in 2023. However, just one third of these economists believe a recession will start in the first quarter of 2023. Therefore, it looks as though the forecast of a recession have been pushed back to the second quarter or even third quarter of 2023.
Other economists point to a “hard landing” and a deep recession, which would likely result in a sharp increase in unemployment, though I think this seems unlikely at this time due to labor shortages.
PIMCO data forecasts a “mild recession” in 2023, which will be later than it originally expected. Although, it does forecast the unemployment rate may need to increase by 0.7% to bring inflation down by just 1%. Thus, in aggregate, PIMCO has forecast the U.S. unemployment rate may need to increase to 5%, up from 3.6% in February 2023, to stave off inflation. We have already seen major technology giants lay off employees in the double-digit percentages. Therefore, this could be an early sign of PIMCO’s forecast playing out.
Is no recession a possibility?
A forecast by Goldman Sachs indicates both the U.S. and the Eurozone can avoid a recession in 2023, which would be a major positive. Goldman Sachs highlighted that its forecasted probability of a recession is just 35% for 2023, which is substantially lower than the average consensus estimate of 65%. This thesis is driven by the fact that Goldman believes the Fed's rate hikes are “front-loaded” and we saw the majority of the impact in 2022.
In addition, the U.S. unemployment rate is just 3.6%, which is substantially lower than the 6.2% rate in February 2021. This is also lower than the over 5% average rate reported between 2014 and 2018.
Moody’s (MCO, Financial) also highlights sound economic “fundamentals” with strong household balance sheets. U.S. households saved trillions of dollars during the lockdown periods due not only to economic stimulus and money printing but also due to lower spending on non-essentials, and thus are actually in a strong position. Additionally, the chart below shows the nominal average family income in the U.S., which we can see is still on the rise, even though it's just rising at about half the rate of inflation or less.
The Producer Price Index (PPI), which measures the average movements in prices received by domestic producers, also rose sharply since 2020 and now looks to have stabilized at ~141 points between November 2022 and February 2023.
Moody’s has dubbed a “slow-cessation” likely, which basically means a slowdown in GDP growth but not a decline.
What does this mean for investors?
Economist forecasts differ widely on whether we will or won’t have a recession. I personally believe an economic slowdown is likely and I have seen this in the earnings data of the many hundreds of stocks I have analyzed over the past year. However, a strong labor market and high household savings could offset any major decline.
