Following a negative GDP print in the first quarter, a strong but inflation-racked economy expanded in the second quarter on a nominal basis, but contracted in real inflation-adjusted terms. The BEA reported “Real gross domestic product declined at an annualized rate of 0.9 percent in the second quarter of 2022 after a 1.6 percent decline in the first quarter. The smaller decline in the second quarter primarily reflected a rise in exports and a smaller decrease in federal government spending.”
Despite the strength of the labor market and consumer spending in the first half of the year, this is the second consecutive quarter of real (inflation-adjusted) economic contraction. Nominal GDP is 7.8% plus annually, but this is mostly due to post-pandemic increases in prices.1
What does this mean for investors?
As we discussed earlier, recessions are important to investors because they reduce employment, reduce consumer spending, reduce corporate earnings, and ultimately drag down profits. On top of this is the sentiment impact, which affects equity multiples. Lower earnings and lower multiples of those earnings are a one-two punch.
My colleague Ben Carlson describes two types of bear markets: recessionary and non-recessionary. Non-recession bear markets fell ~25.9% on average, while recession bear markets hit a much higher 39.6%. Note that these are averages, and they have a wide dispersion of 20% to 33.5% for run-of-the-mill bear markets during recessions, from 20% to 86.2%.2
The bad news is that we’re stuck with the debate over the meaning of 2 consecutive quarters of negative GDP as three more months of recession. The good news is that it lowers expectations for the FOMC to go 75 basis points in September. Market reaction is almost non-existent, a slowdown or even a mild downturn already suggests pricing.
2 Types of Bear Markets (Common Knowledge Resources, May 22, 2022)
in the past:
Soft Landing RIP (July 25, 2022)
Why Recessions Matter to Investors (Jul 11, 2022)
Too late to sell, too early to buy… (Jun 16, 2022)
GDP Update: -52.8% (June 2, 2020)
Cherry Picking Your Favorite GDP Forecast (May 18, 2016)
1. Note that the Atlanta Fed’s GDP reading got the direction right but the magnitude wrong.
2. This assumes you accept the 20% rule of thumb as meaningful…
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