Five things to know about a recession

The big “R” word.

Chances are you read about it, you hear about it and you even think about it. Given today’s state of rising inflation, the U.S. economy could be headed for (or may already be in) a recession. But do you often wonder, what happens during a “recession”? If you do, you’re not alone. It’s not an easy topic to understand.

After all, recessions can be unsettling for a number of reasons. When the country’s economy is experiencing a widespread downturn, that usually results in higher unemployment rates, lower consumer spending and other investment challenges across the board. On a personal level, you may have concerns when it comes to your overall financial situation, like buying a new house or keeping your job.

If a recession is in the cards, here’s what you need to know to navigate the current climate and stay on track with your money:

1. What is a recession?

Simply put, a recession is “a period of significant decline in economic activity.” Although the exact definition may vary, many experts consider a recession to be two consecutive quarters of decline in gross domestic product (GDP). The market as a result may experience major plunges and volatility over several months.^1,2

Since the S&P 500 Index was established in 1957, the U.S. has been through 10 official recessions, with the Great Recession causing the most severe shifts and declines in the market since the Great Depression of the 1930s. The crisis itself lasted from December 2007 to June 2009 beginning with the subprime mortgage meltdown, which featured an extreme increase in defaults on high-risk housing loans. Millions of people across the world ended up losing their savings, jobs and homes during the collapse.^3,4

2. What causes a recession?

For starters, it’s important to know that while recessions can seem scary, they are a regular part of our economic cycle.⁵ In addition, each recession is fundamentally different from the previous one and has its own characteristics.

Overall, though, a recession is usually caused by a string of negative developments in the economy like supply chain issues or rising inflation. (Does that ring a bell?) As inflation goes up, the chances of a recession do, too. That can lead to more layoffs, few job opportunities and increased interest rates, which in turn causes people and businesses to be more conservative with their money and cut back on spending.⁶

Think of it this way: If the cost of a plane ticket gets really expensive, you may decide not to travel as much until things improve. As a result, the more people who take a break from flying, the more it may impact airlines, their pilots and crew members. It’s like a domino effect.⁷ Once the line starts falling, it can be hard to stop.

3. Are we in a recession?

It’s complicated.

To begin 2022, the GDP, which measures the values of all goods and services in the U.S., dropped at an annual mark of 1.6% for the first three months of the year and then 0.6% in April, May and June.⁸ Some traditionalists and economists may argue that yes, in fact, we are in the middle of an actual recession. But the real answer to the question tends to be little more subjective in the grand scheme of things.  

The National Bureau of Economic Research (NBER) is the entity that officially makes the call on a recession. The NBER considers a wide range of factors far beyond GDP when determining whether a particular cooling-off of economic growth qualifies as a true recession, or merely a pause in a longer period of expansion. Employment, consumption, retail sales and production are just a few of the measures it weighs. However, as of now, the NBER has yet to formally declare a recession for this tough stretch.^9,10

4. How do markets behave in a recession?

Markets are actually able to anticipate periods of weakness before they become deep enough to qualify as a recession.

For instance, as Empower data shows, stocks typically peak and begin dropping roughly three to seven months prior to the onset of recession. In a similar way, stocks also seem to anticipate the end of a recession by beginning to recover roughly six months before economic activity bottoms out.

“Maybe the most encouraging message is the idea that by the time a recession begins, markets may have already done a fair job of “pricing in” much of the damage,” said Tom Nun, Empower portfolio strategist.

The implication is that the market may have already suffered a majority of its declines by the time the NBER officially declares a recession. In fact, during the modern era (1945 to present), Empower data suggests that both the average and median equity market return during an actual recession may have actually produced slightly positive results.

In other words, by the time the check comes due, markets have, in some cases, already paid most of the tab.¹⁰

5. How long does a recession last?

Every recession is unique.

But U.S. downturns have become somewhat shorter and less frequent as the American economy has matured. The COVID-19 recession in 2020, which saw roughly 22 million jobs erased, lasted just two months and is the shortest recession on record.¹¹ In general, though, the average recession in the modern era (1945 to present) lasts about 11 months. That’s because the U.S. economy has become more sophisticated, flexible and adaptive over time.

“One possible reason for this phenomenon is the rapid implementation of policy measures that are designed to combat recession that has become so commonplace in the modern era,” said Tom Nun, Empower portfolio strategist.

The bottom line

Nobody knows for sure what lies ahead for the economy or for their investments, because each recession is fundamentally different from the last. The good news? If history is any guide, it might not be as bad as people think.