Waiting for a Recession to End May Carry Opportunity Cost
Since 1979, when the National Bureau of Economic Research began to formally announce the beginning and ending dates of U.S. economic recessions, the U.S. economy has fallen into recession five times. In each case, the recession was between six months and one year old before the NBER was able to detect it and announce its beginning date. The bureau took an average of 15 months after a recession was over to announce when it had ended.
Recessions take a psychological toll that almost certainly spills over into the early months of a recovery. Because it can take so long for the NBER to determine when a recession began or ended, people who delay financial decisions until they are certain a recession is over are at a disadvantage because they may be operating on old information.
The NBER is a venerable organization whose role as the nation’s official recession timekeeper is widely accepted. Nonetheless, its methods are little known by the investing public. Placing too much faith in the NBER’s recession/recovery announcements without understanding what they mean may result in false assumptions and poor decisions.
Peaks and Troughs
Even though most (but not all) recessions have included two or more quarters of negative growth in gross domestic product — the widely accepted benchmark of a recession — the NBER has a more stringent definition. It prefers to focus on broader measures of economic activity, defining a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.”
In the NBER’s language, the economy travels through a business cycle that is marked by peaks and troughs. A peak in economic activity represents the end of an expansion and the onset of a recession. A trough represents the end of a recession, when economic activity reaches a low point that is followed by sustained growth.
When You Least Expect It
This means that many recessions occur when they are least expected, when the economy is operating at peak levels. For example, when the recession began in December 2007, the unemployment rate was 4.9% and real gross domestic product was growing at 2.1%.2 This also means that a recovery often begins at the darkest moment, when production, income, and employment are at their lowest levels.
The NBER has garnered widespread respect because it has rarely had to revise a business cycle date. It makes no attempt to announce recessions or recoveries quickly, but waits long enough so that the timing is not in doubt.
The NBER uses an array of tools and measurements to identify peaks and troughs in the business cycle, but perhaps its most important tool is hindsight, something investors don’t have the luxury to consult. Making financial decisions only when you believe the economy is on solid ground could mean missing opportunities in the critical early months of a recovery.