Recessions: How Does This One Compare?

December 31, 2008

It's official: We're in a recession.

Considering the severity of the financial crises, how does this recession stack up against all the other post–World War II recessions?

Although we believe this recession, (which started in December 2007), is consumer-led, it's also affected by the extraordinary combination of headwinds associated with the credit markets, the protracted nature of the deleveraging process, tight lending standards, reduced consumer and business confidence, still-falling home prices and the lingering effects of previously high energy prices. Moreover, we believe this recession is global in nature and is still spreading.

Defining recessions
At the outset, let's define what a recession actually is.

Recessions are oftentimes inaccurately described as a back-to-back decline in quarterly readings of gross domestic product (GDP).

The National Bureau of Economic Research (NBER) is the official arbiter of calling recessions. It defines 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."

Recessions and the stock market—trying to find the bottom
The stock market remains one of the best barometers of the direction of the economy.

The following graphic compares the price performance of the S&P 500 index with the average of the 10 NBER-declared recessions from 1947 to the present. See the table at the end of this article for a summary of each of the 10 recessions, including actual dates, length and key features.

Markets typically anticipate recessions

Performance relative to the numbered arrows. 1–2: Peak-to-trough average decline = 25%. 2–3: Trough-to-recession end average gain = 24%. Indexed price-only data from 1947 to March 31, 2002. Source: Ned Davis Research, Inc.

To better understand how recessions typically work, note these four important trends:

On average, the S&P 500 has started to lose ground approximately seven months before recessions began.
Recessions have lasted an average of 10 months.
On average, the stock market has started to recover six months into the recession or four months before it ended.
It took approximately 13 months for the stock market to traverse from its peak to its trough.

These averages might not apply to the current recession, but we believe there's a strong chance that some trends could repeat. For example, the stock market could anticipate the beginning and end of the recession before the economic data reflects it.

Even though all recessions are not the same, let's look at what we do know about where the stock market and the economy are within the current business cycle. We know that the S&P 500 peaked in October 2007 and is still trying to form a bottom.

The NBER declared that the recession started at the end of December 2007. Although we can't proclaim just yet that the November 2008 year-to-date low in the S&P 500 is the bottom, the peak-to-trough process for the stock market would be approximately 13 months long to that date and the recession is nearly 12 months long—so far.

We also know that the U.S. government (and some of our major trading partners) have orchestrated an unprecedented amount of stimulus into the system and introduced several liquidity-enhancing mechanisms.

Even so, given the unprecedented challenges in this economic environment, we think that this recession could drag out for several more months—much longer than the historical norm. The coordinated government aid is unprecedented, but it matches the magnitude of the combined challenges. We could be in for a long wait until we find the stock market's floor.

Key components of recessions: past and present
The following table covers all 10 of the post–World War II recessions officially declared by the NBER. It also provides the status for the current recession.

For discussion purposes, it's easier to refer to each of the declared recessions by number as listed in the other table at the end of this article detailing their history. The recessions that were predominantly "business-led" were deemed to be numbers one and 10 (averaged). Keep in mind that businesses also suffered in the other recessions, as well (except for number five).

The only recession that was considered predominantly "consumer-led" was number nine. But here too, consumer spending was also negative during recessions number three, six and seven.

Key components of recessions: past and present
	All recessions	Business-led	Consumer-led	Current recession¹ (so far)
GDP	–1.9%	–0.4%	–1.9%	+1.1%
Income	–2.2%	–2.1%	–3.6%	–1%
Nonfarm payrolls	–2.9%	–3.7%	–1.7%	–1.5%
Industrial production	–9.8%	–7.8%	–5.7%	–6.2%
Wholesale-retail sales	–6.2%	–0.3%	–6.2%	–4.2%
Consumer spending	+0.3%	+2.8%	–1.3%	–0.6%
Business spending	–6.8%	–13.2%	–6.2%	+1.1%
Average length	316 days	290 days	243 days	335 days
Peak unemployment rate	7.6%	7.1%	7.8%	6.7%¹
Months after recession	4.8 months	9.5 months	15 months	?
Residential spending	–12.3%	+0.9%	–23.4%	–20.7%
Government spending	+2.2%	+7.0%	+2.1%	+3.7%
Net exports (as a % of GDP)	+0.2%	0.0%	+0.7%	+1.1%

1. Data for "current recession" is through September 30, 2008, with the exception of income, nonfarm payrolls, industrial production, wholesale-retail sales, average length (so far) and the unemployment rate, which are through November 30, 2008. Per the NBER, the start date for this recession is December 31, 2007. All percentages, except the peak unemployment rate and net exports are compounded annualized rates. Sources: FactSet, Bureau of Economic Analysis, Bureau of Labor Statistics and the Conference Board.

Note that this sample space of just 10 recessions is statistically small. In addition, only two were clearly business-led and one consumer-led. It's difficult to oversimplify and categorize any recession into either consumer- or business-led. At times it was the Fed, oil, housing or credit issues, and when some of these causes overlapped, both consumers and businesses suffered. For example, recession number seven (1980) was punctuated by the worst showing of consumer spending (–4% annualized) and business spending (–19% annualized) compared to all the other recessions.

The recessions in the early years tended to be caused by the Fed being overly restrictive for too long when it came to raising interest rates to fight inflation. Moreover, the Fed likely exacerbated the depth and duration of recessions when reacting to high energy prices.

In the past, it was common for the Fed to raise rates to fend off inflation. The most noteworthy example of this took place under Paul Volcker's chairmanship of the Fed in the 1980s. He intentionally directed the Federal Open Market Committee (FOMC) to raise rates forcefully—knowing full well growth would suffer—in order to finally break the back of inflation.

Now, in contrast, the Fed recognizes the taxlike effect of high energy prices and its associated restriction on the economy. So, if the economy is growing at a subpar pace, the Fed has now learned that it's better to cut rates in order to help the economy grow, rather than be concerned with inflation from high energy prices.

This assumes that no other meaningful sources of inflation would be threatening the economy. And to the extent that some degree of unwanted inflation did exist, it isn't necessarily worrisome because this lagging indicator would be expected to eventually subside given the subpar pace of the economy.

As detailed in the "History" table below, what's noteworthy about this and the previous two recessions is the length of time it takes for the unemployment rate to peak after a given recession ends. It's nowhere near the overall average of 4.8 months. Recession number nine took 15 months, and number 10 took 19 months.

Is this a new trend that will show up for this one, as well? If so, consumer spending could languish a lot longer than usual after the recession is over. The strain on consumer sentiment and income because of too many people being unemployed would likely add to a lag in consumer spending. Under that scenario, investors may want to hold on to their investments in the consumer staples sector longer and not jump into the consumer discretionary sector too soon compared to previous recessions.

Also, too many economists and analysts like to point out the economic lift and benefit stemming from the positive results for net exports. While that economic fact is true, it doesn't seem to be enough to prevent recessions: Net exports have been positive in seven of the past 10 recessions.

For the past few decades, the use of technology has provided a boost all around. It's been utilized to more effectively manage inventories of goods, thereby helping to minimize the length of recessions. When demand is slack, corporations are left with the choice of cutting prices or sitting on unwanted stockpiles. The more you have, the longer it takes to go through this process. In the earlier recessions, these inventories of goods had a tendency to become more bloated.

The one problem today with this unquestionably good attribute from technology is that inventories are more associated with the production side of the economy. But since approximately the 1960s, the makeup of the economy began to shift more and more toward being a service-oriented economy, usually associated with no physical inventories.

Therefore, lean inventories today, while helpful, don't necessarily translate into as much of a benefit compared to the earlier, more production-oriented years of our economy.

For this recession, we see several overlapping negatives, most notably housing, the credit crisis and high energy costs. Unfortunately, the problems are global. In prior years, any of those first three factors alone could have been enough to cause a recession.

Because the deleveraging process started from such a very high plateau, we're clearly experiencing an unprecedented recession. Fortunately, the stimulus and liquidity-enhancing measures are also unprecedented. Also, many businesses appear to be in much better shape in terms of respectable balance sheets and relatively lean inventories. However, for this extraordinary time in our history, there don't appear to be any catalysts that we can see to bring the economy out of its funk—other than time.

History of post–World War II recessions
Number	Dates (start – end)	Duration (in days)	Key features
1	11/30/48 – 10/31/49	335	Business spending, industrial production and payrolls declined, offset somewhat by strong consumer spending.
2	07/31/53 – 05/31/54	304	Fed left interest rates too restrictive (high) for too long in fear of inflation after the Korean War; industrial production and payrolls declined.
3	08/31/57 – 04/30/58	242	Fed tightened monetary policy too much once again, business and consumer spending plummeted along with industrial production.
4	04/30/60 – 02/28/61	304	Residential spending took a hit and industrial production slowed in the face of rising inventories, tempered by strong service sector growth. A portion of the economy that was at the beginning stage of the multiyear phase of becoming more meaningful toward supporting overall economic growth compared to industrial production.
5	12/31/69 – 11/30/70	334	Several key economic indicators were soft, but nothing extreme.
6	11/30/73 – 03/31/75	486	Energy prices soared and the lingering challenges from the Vietnam War caused most of the economic indicators to take a harder hit compared to the previous recession, but strong net exports took some of the sting out.
7	01/31/80 – 07/31/80	182	Energy prices surged and the Fed continued its pattern of raising interest rates too much; most of the economic indicators experienced a noticeable decline, particularly residential and consumer spending, but strong net exports once again offset some of the pain.
8	07/31/81– 11/30/82	487	Energy prices surged and the Fed continued its pattern of raising interest rates too much; unemployment skyrocketed and several key economic indicators were soft, countered by reasonably good consumer spending and the beginning of the multiyear phase of corporations relying more and more on debt (levering) to finance operations.
9	07/31/90 – 03/31/91	243	Consumer spending declined and other key indicators were soft, particularly personal income and payrolls (the unemployment rate finally peaked 15 months after this recession ended), as they were affected by the lingering effects of the S&L and junk bond crisis, as well as the first Gulf war, yet were partially offset by favorable net export growth and because the deleveraging phase back then was short lived: Corporations quickly resumed their over reliance on debt to fund operations.
10	03/31/01– 11/30/01	244	Tech bubble burst, 9/11, accounting scandals. As with the previous recession, jobs came back extremely slow as it took 19 months for the unemployment rate to peak once this recession ended.

As always, we will continue to provide articles to help you discern where the economy is within this business cycle. To learn more, read "Recovery Watch 2009" by Liz Ann Sonders.

If you have questions or need help, please contact your Schwab consultant. If you're not yet a Schwab client but would like to learn more, a Schwab consultant can help. Call 800-435-4000 to get started.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative (or "informational") purposes only and not intended to be reflective of results you can expect to achieve.

(1208-4021)

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