What is ‘a recession’?

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Neon Arrow Pointing Downwards

The U.K announced earlier this week that it was officially in a recession for the first time since 2009 after results of the first two quarters of 2020 showed a significant decline in GDP (Gross Domestic Product).

This was much expected by most due to the, almost complete, shutdown of the economy, particularly in sectors like hospitality, retail, and travel.

But what does it actually mean for an economy to be in a recession? How frequent are they? What does it mean for the average person? And is it really as bad as the headlines make it out to be?

Definitions can vary slightly from country to country, but a recession is generally defined as ‘two successive quarters of negative economic growth’, measured by seasonally adjusted GDP (this also applies to all other EU member states).

You can see, in the below graph, how the U.K has experienced growth in almost every quarter since 2009.

Graph Showing Two Months Of Economic Decline

Not all recessions are as immediately impactful as the likes of the collapse of 2008, caused, in large part, by the US housing crash, or by the one we’re currently facing where large swathes of global businesses have been forced to postpone trading.

Some of the time these declines in economic growth come at a lot slower a pace.

Gradual declines in company earnings brings about the slowly rising unemployment rate. As a result, banks increase interest rates due to increasingly high risk lending; higher interest rates create less disposable income for consumers; less disposable income means less money going back into businesses, and by proxy, the economy producing the full circle of slow decline.

 

How common are recessions?

Economic expansions tend to last considerably longer than recessions, on average. Quite a bit longer, in fact.

Taking our most recent ‘bull run’ (a period of extended growth) as an example, since the end of the recession of 2008, we experienced over 125 months of continuous growth. Compare that to how long the recession itself lasted – ~15 months – that’s quite a lot longer.

However, this sort of decline can have a lot sharper, quicker downturn than it takes for the recovery to reach its previous highs (a decline of 50% requires growth of 100% just to get back to where it started).

Since the 1990s, the US, U.K and another number of western European countries have experienced 3 recessions of varying lengths and extremes. In contrast, Japan have seen twice that amount during the same time period.

The first significant recession recorded in the U.K was that of the ‘Great Slump’ in the 15th Century. This lasted for around 40-60 years.

Caused by shortages in supplies of silver, as well as the multitude of trade fallouts across Europe as a result of the Hundred Years’ War, England experienced a decline in economic activity that slowly spread throughout the latter part of the Middle Ages.

Looking at a more recent history, since the end of the Second World War, the U.K has experienced some eight significant recessions.

With the Suez crisis deepening, 1956 saw the first two quarters of negative growth since the Great Depression of the 1930s.

Subsequent recessions have occurred in the U.K in:

  • 1961
  • 1973-74
  • 1975
  • 1980-81
  • 1990-91
  • 2008
  • 2020

And this is just looking at the U.K. There have been many more isolated examples across the globe.

The U.K did, however, manage to avoid a recession during the dot-com crash of the late 90s, early 00s, despite the US and other major western countries doing so.

So recessions are far more common than the average person may realise, but can have quite the varying impact on the everyday person…

 

What does this mean for the average person?

Despite all the headlines and emotive language in the press recently, at the announcement of an official recession, they’re not necessarily always a bleak predictor of the next [X months] to come.

As I’ve already explained, recessions are measured against a country’s GDP. But GDP doesn’t always portray the full story.

What makes a recession more impactful or not is “who” it affects and “how badly” it affects those individuals or industries.

Recessions can have more of an impact on certain groups of people over others depending on the root cause/s.

For example, the 2008 recession appeared even more impactful as it not only effected the everyday individual, working pay cheque to pay cheque, but also impacted those on significantly higher incomes in the housing, banking and finance related sectors owing to it stemming from the banking and housing crises.

This current recession could be even more significant for those on a lower income with their industries being those that have been most effected (not that everyone hasn’t been in some form or another), with banking, finance and established technology sectors generally having been able to continue trading, with some even thriving. But this is all conjecture at this early stage of course.

 

What does this mean for investors?

Recessions, predictably, breed uncertainty, and are often volatile times for investors.

For long-term, growth investing in a broadly diversified portfolio, recessions can offer quite the opportunity for those that manage to remain employed with a stable inflow of cash.

The price of Amazon stock in August 2008 was just $75. It’s now over $3,100.

Facebook was $38 during the same period, and is now over $250.

Again in August 2008, the FTSE250 Index price – a good determiner of actual domestic U.K stock – sunk to a little over 5,000 points. At it’s peak at the end of last year, it hit a little over 22,000.

There are many, many more examples of this across the various indexes and individual stocks.

Of course, there are always losers, and when we’re talking about economic collapse, even the biggest companies can’t always hide from the rolling tide of bankruptcy.

Almost 27,000 companies went bust by the end of 2009 in the U.K alone with one notable ‘biggy’ being Northern Rock.

Lehman Brothers in the US were also another huge company to succumb to the financial pressures and companies like GM (General Motors), while still trading to this day, have never really recovered. For investors in these companies, long-term investing wasn’t so lucrative.

It further emphasis the need for a diversified, long-term approach to investing.

The old adage is “No company is too big to collapse”, so why would you risk putting all your eggs in one basket.

 

 

References:

https://www.standard.co.uk/business/uk-economy-historic-recessions-a4520961.html

https://en.wikipedia.org/wiki/List_of_recessions_in_the_United_Kingdom

https://www.forbes.com/sites/steveschaefer/2011/08/10/the-great-recessions-biggest-bankruptcies-where-are-they-now/#169aec304b7e

https://en.wikipedia.org/wiki/Great_Slump_(15th_century)

https://www.investopedia.com/terms/r/recession.asp

https://www.investopedia.com/terms/r/recession.asp

https://www.bbc.com/future/article/20200810-is-there-such-a-thing-as-a-good-or-bad-recession

 

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