• Recessions and depressions share certain characteristics. However, those traits are more pervasive during depressions than recessions.
• Recessions are considered a natural aspect of the functioning of an economy, while depressions are not.
• Smart investors can actually prosper during recessionary periods.
“Brother, can you spare a dime?”
Penned in 1932, this refrain from the song of the same name was part of the unofficial anthem of the Great Depression, which followed the economic crash of 1929. As the song so capably illustrates, depressions are devastating events, possessing the ability to completely decimate an economy.
Meanwhile, recessions are considered a natural aspect of the functioning of an economy, while depressions are not. In fact, expansions and contractions are as endemic to economies as are the tides to the sea.
So, what’s the difference between a recession and a depression?
Economists characterize recessions as at least two consecutive quarters of decline in GDP (gross domestic product). However, there’s a bit more to it than that — in practice. According to the National Bureau of Economic Research, a recession is a period of significant decline in economic activity, encompassing a large segment of the economy, which lasts more than a few months.
Declines in real GDP and incomes, as well as in industrial production and retail sales, are the key indicators of an economic recession. Other traits include high unemployment and a resulting lack of consumer spending. This, in turn, slows home sales, which accelerates falling prices. Stock market declines also result.
Again, though, recessions are considered a routine aspect of economic cycles. In fact, as of this writing (September, 2022) the U.S. economy has experienced 13 recessions since the end of World War II.
At its essence, a depression is a recession that continues for several years and inflicts exceptional damage upon the economy. As an example, the Great Depression of 1929 lasted until 1939 and was absolutely shattering in the harshness of its effects.
Depressions typically register unemployment numbers well into double digits, which remain lodged there for years. This triggers a collapse in the demand for consumer goods, which in turn finds companies severely curtailing production and shuttering production facilities.
As an example, the Great Depression was a worldwide event that left 12.8 million people jobless in the United States alone. Wages retreated by an average of 42.5% in the U.S. The nation’s real GDP retreated by 29% and nearly 1/3 of the U.S. banking system collapsed under the strain. Some 7,000 American banking concerns folded between 1930 and 1933.
However, economists tend to disagree on the bookending of depressions. Some consider the economy to be depressed during the period within which it is declining — until it hits rock bottom. Others consider a depression to be in effect until economic activity has rebounded to the level at which it was functioning when the retreat began.
The most significant recession in recent history (the Great Recession) ran from 2007 to 2009. Meanwhile the Great Depression lasted 10 years. Unemployment hit 10.6% during the Great Recession, while it spiked at 24.9% during the Great Depression.
The Great Recession saw GDP decline 4.3%, while the Great Depression topped out at 29%. In the past, recessions tended to honor the borders of a single nation. Today, globalization has made recessions multinational occurrences.
The Great Depression saw home prices decrease by 67%, while the Great Recession, which was triggered by a collapse in the U.S. real estate market, saw home prices decrease by 30%.
In short, while the Great Recession did have a significant effect on the economy, the consequences of the Great Depression eclipsed it handily.
One of the most accurate predictors of recession has been the emergence of an inverted yield curve. In fact, such curves have signaled the emergence of each recession that has occurred since 1955. These typically occur when longer-term debt becomes cheaper than short-term debt.
During times when investors begin to have concerns about the performance of the economy, such investors look to exchange short-term debt for long-term debt, which causes interest rates associated with short-term debt to rise. This is considered an inversion because long-term debt is typically looked upon as posing more risk, and therefore commands greater reward.
However, when the threat of recession looms, concerns over short-term debt’s ability to weather the coming storm emerge. This causes interest rates to rise because taking it on is perceived to pose more risk.
Private Market Investing 101, with Kal Penn
In the wake of significant consumer price increases, the U.S. Federal Reserve is currently doing everything within its power to decrease inflation. While an admirable endeavor, this activity has the potential to trigger a recession, which many experts think is already looming.
In an interview with U.S News & World Report, Jim Baird, chief investment officer at Plante Moran Financial Advisors, said, “There’s no way to know definitively when or at what level the Fed’s policy rate will peak. However, there should be little doubt that policymakers are firmly focused on bringing inflation back under control, even if it results in outright job losses and a recession.”
And indeed, Jerome Powell, chairman of the Federal Reserve, has announced the Fed’s intention to make every effort to bring inflation under control — even though efforts could mean economic pain for both consumers and industry.
While 2023 does appear to be shaping up to be a recessionary year, experts say there should be no concerns about the economy slipping into another depression. Comparing the economic structure of today to 1929 reveals the sheer number of mechanisms that have been put in place to avert the recurrence of an economic meltdown of that magnitude.
The Federal Reserve now works more diligently to manage and mitigate potential economic crises. There are also several governmental safety nets in place for consumers in place that did not exist back in 1929. These include unemployment insurance and stimulus checks.
Moreover, the FDIC now insures depositors’ funds in banks up to $250,000. And, the Dodd-Frank Act of 2010 mandated greater transparency and accountability for financial institutions. These actions have both strengthened and stabilized the banking industry, while equipping consumers and the economy to deal with economic downturns more easily.
So, while recessions will still occur, depressions are highly unlikely.
The first rule of managing a portfolio during a recessionary period is avoiding panic. Investors must repress their emotions and instead focus on logic. Panic selling has left many investors regretful of positions they sold when they should have been buying more instead.
With that said, growth stocks are usually best avoided during periods of recession, because the opportunity for growth may be limited. Dividend paying stocks can potentially be good to have during recessions, as they can be income-producing equities. Recessions are also a good time to employ dollar cost averaging, as shares can be acquired while prices are falling. Reinvesting dividends rather than liquefying them is another smart play.
Avoiding companies with high debt loads, in favor of those with all-weather business models, can potentially help preserve the value of a portfolio during a recession as well. “Defensive” stocks such as utilities, consumer staples and health care usually withstand recessions well.
As always, the key is to ensure portfolio diversification to balance out potential exposure to segments of the economy that underperform during periods of recession.
Alternative investments can also be potentially useful tools for portfolio diversification, which is generally agreed upon by experts to be a smart investment strategy to pursue. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to recessions.
Real estate, private equity, venture capital, digital assets, and collectibles are among asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification.
These asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million. Yieldstreet opens a number of investment strategies that were formerly available only to institutional investors and the top one percent of earners to all investors.
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While recessions are a normal aspect of the economic cycle, depressions are not. Many safeguards have been put in place since the Great Depression following the Crash of 1929 to minimize the likelihood of another depression ever taking place.
Meanwhile, a recession can represent opportunity for the savvy investor, as stocks with strong underlying fundamentals tend to be undervalued during those periods. What’s more, incorporating alternative investments into a portfolio can better help an investor weather a recessionary period as well.
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