Dave:
What’s going on, everyone? Welcome to On The Market. I’m your host, Dave Meyer. If you haven’t heard already, last week, the BEA also known as the Bureau of Economic Analysis announced that real gross domestic product had dropped 0.2% in Q2 of 2022. Now, this is important and really newsworthy for several reasons. First and foremost, anytime GDP declines, it is noteworthy. That means that the US economy is contracting and as investors or just as everyday Americans, we should be wondering why the economy is declining and trying to understand what happens next.
Now, this news is even more noteworthy because this is actually the second consecutive quarter of real GDP decline. And if you were paying attention back in Q1, real GDP dropped 1.6%. And so now two quarters in a row, the first two quarters of 2022, we have seen real GDP decline. And the reason this is so noteworthy is because two consecutive quarters of GDP declines is the most commonly accepted definition of a recession.
I’m going to get all into this today, but obviously this causes some fear and concern because we are now hearing a lot of people saying that the United States is in a recession. I wanted to make this episode because there are a lot of questions about this. There’s a lot of confusion and honestly, there have been a lot of heated arguments I’ve seen about whether or not we are technically in a recession, what this means that we’re in a recession, what we should do about it. And so I decided to make this episode to dive into all this.
We’re going to talk about what actually got announced this last week. We’re going to talk about whether or not we are officially in a recession and then we are going to talk about the history of recessions and the implications for investors about what the current economic environment means. But before we jump into this super important topic, we’re going to take a quick break.
Okay. First things first, let’s just jump into what actually was announced this last week. On July 28th, the Bureau of Economic Analysis released the Q2 GDP data. Now, if you’re not familiar with the term GDP, that’s fine. It stands for Gross Domestic Product. And what it is basically if you added up all of the value of the goods and services produced in the United States in the second quarter of 2022, if you summed all of that information, all of the value created there, that’s what Gross Domestic Product is.
It is generally how economies all across the world are evaluated at the highest level. Now, there are tons of other economic factors that advanced economies use to evaluate production and output, but GDP is basically the most commonly accepted highest level analysis of an economy. So the US government specifically the Bureau of Economic Analysis puts out GDP data every single quarter.
Now, sometimes this announcement, it just goes by and some stock traders and people who like me just follow the economy closely, pay attention to it, but this particular announcement was watched really closely because real GDP declined back in the first quarter of 2022. And if it declined again, it would meet the classic definition of a recession. So a lot of people were eagerly awaiting this announcement to know whether or not the US now falls under this classic definition of a recession.
And what happened? Well, real GDP did decline for the second consecutive quarter. It was actually down 0.2% in Q2 or that’s 0.9% if you annualize that out to an entire year. So the US now meets that classical definition of a recession. And before we get into what this all means, let me just go into a quick note on some terminology here.
Real GDP. If you’ve been noticing, I keep saying real GDP. Real, “real” means inflation adjusted. And this is really important because you see if you looked at the opposite of that which is known as nominal GDP. So that’s not inflation adjusted, they tell totally different stories. So when you have real GDP, inflation adjusted GDP, it went down in Q2. But nominal GDP, which is not inflation adjusted at all, it actually went up. It went up quite a lot. It went up 7.8%.
And this is a super noticeable difference, right? 7.8% growth in GDP during normal times would be enormous. People would be singing its praises and would be so excited, but inflation is so bad right now that it is more than canceling out all of that growth as reflected in real GDP, right? If there was zero inflation, we could look at that nominal 7.8% and be super excited about it.
But the reason we have to look at real GDP is because inflation is devaluing the dollar and that means that when you account for that, the actual growth in the economy was slightly negative in the second quarter. So this is just something that drives me nuts because a lot of like really big reputable data sources, media sources will publish GDP data and not clarify whether it’s real or nominal.
So just as a note if you are looking into this information, make sure to check which one you’re looking at, because they’re both valuable measurements, but they are very different ones. And for the rest of this episode, I am going to be talking about real GDP. Again, that is inflation adjusted GDP because I think that is probably the most important thing that we can all look at this.
Now, I interpret all this information one way. You might interpret it differently. There are so many different variables in the economy, but overall, I mean, I don’t think anyone can really argue that negative real GDP is not a good thing, right? It means that inflation is overshadowing US productivity, right? As I just said, if there was no inflation right now, the US would’ve grown at nearly 8% which is amazing. But instead, when you adjust for inflation, as you should, it is negative.
So this is a really important difference. And again, I think that this shows weakness in the US economy. The big question now seems to be are we actually in a recession? And if you pay attention to the news or to social media, you probably see people arguing about this a lot right now. And it seems like it should be a simple answer, but unfortunately it’s not.
So I did some research just to figure out what is behind this entire debate. And let me just explain to you why it’s not so clear whether we are technically in a recession right now. So first, most people accept that two consecutive quarters of GDP declines equals a recession. Many people believe this makes it officially a recession, but that’s not actually the case.
So again, people generally accept that, but to get, quote-unquote, officially a recession, there is only one group of people who can do that and it is not as simple as two consecutive quarters of GDP decline. In fact, it is done by a group called the National Bureau of Economic Research. And specifically it is done by this very strangely named group called the business cycle dating committee. They put out dates around business cycles. There is no romantic dating that I know of at least going on, and it is just a bunch of academics basically.
This is a bunch of economists from universities across the country, and they look at an overwhelming amount of data to make their determination of whether or not we are in a recession. And as their very strange name indicates, their job is basically to decide when the recession starts and when the recession ends.
So how do they do that, right? Because most of us are walking around thinking two consecutive quarters of GDP decline, that’s a recession, right? Well, they look at it in a more complicated way. They say according to their website and I quote, “A recession involves a significant decline in economic activity that is spread across the economy and lasts more than a few months.”
That’s obviously not as simple a definition as two consecutive quarters. They go on to say, “In our interpretation of this definition, we treat the three criteria, depth, diffusion and duration as somewhat interchangeable. That is while each criterion needs to be met individually to some degree, extreme conditions revealed by one criterion may particularly offset weaker indications from another. Because a recession must influence the economy broadly and not be confined to one sector, the committee emphasizes economy wide measures of economic activity. The determination of the months of peaks and troughs is based on a range of monthly measures of aggregate real economic activity published by the federal statistical agencies.”
Whoa. Okay. That was a lot of big words and random stuff, but basically what they are saying is that they look at a lot of different stuff across the economy. It has to be across different economic activities, right? That’s something that they said that it doesn’t really come down to one standard definition. They are looking at the depth of economic decline. They’re looking at the duration of economic decline and they’re looking at how broadly it is spread across the economy. And they also said that they are basing it off real economic activity.
So they are saying what we were just talking about, that they base it off inflation adjusted numbers. Okay. So I know that’s pretty wonky and it’s notable that these people, the National Bureau of Economic Research, basically the only people allowed to officially call a recession have a very complicated definition of a recession, right? After I read that, we can all agree on that they are not just saying it’s two quarters of GDP decline.
So that is the important piece. The other important piece that I uncovered when I was researching this is something else they said. So they write and I quote, “The committee’s approach to determining the dates of turning points is retrospective in making its peak and trough announcements. It waits until the sufficient data are available to avoid the need for major revisions to the business cycle chronology.”
I know. Another really wonky, big word sentence, but basically what they’re saying is that the only people who are able to make the official recession designation say that they don’t do it in real time. They are not trying to decide right now today, “Are we in a recession?” They like to look backwards and say, “Okay, let’s look at what happened in 2022 and we’re going to decide when the recession really started and when it really ended.”
They always do it retroactively. Listen, I think it’s annoying and frustrating that it is not in real time, but in some way it does make sense because look at their definition, right? They’re saying they have to look at all this crazy data to make the determination. And if they have to look at that much data, according to them, then I understand it’s going to take some time to look at all this data. Unfortunately for us, the debate about whether we are in a recession is going to go on for some time.
Let me just show you something that I found actually on the Wall Street Journal. And it showed that just some recent examples, the 2001 recession, which was some people call like the dot com boom bubble burst, whatever, started in March 2021. That’s when it officially started, but the NBER only announced that in November of 2021. So eight months later. The great recession, which officially started in December of 2007 wasn’t announced until December of 2008. That is a whole year later.
The COVID recession, which is the most recent one, which started in February of 2020 was announced in June of 2020. So that one was actually relatively quick. Only four months later. But I know people get frustrated about this. They argue about this and they say that it’s all political. And there is obviously politicking going on. This is the United States after all. But there is just precedent. This is always what happens. This isn’t a change based on current economic conditions. The official designation of a recession always comes months after it actually starts.
So I actually didn’t know that. I thought that was really interesting. Something to help you all understand why there is still room for people to debate this and why people are debating this so much is because it’s going to be several months until we actually know for sure. So everyone wants to know are we in a recession? Most people would say yes because we have seen two consecutive quarters of GDP declines. Some people are going to say no, and we don’t know officially for sure.
Now, my personal opinion, and I know this is probably going to be different than what most people think is that it doesn’t really matter. I know that sounds counterintuitive, but my point is that the definition and whether the current time period is labeled as a recession, it doesn’t really matter to me.
Let me just be clear. I’m not saying that a decline in economic growth doesn’t matter. That absolutely matters. The fact that GDP, real GDP is declining, absolutely matters that it’s extremely important. What I’m saying is that whether or not we are officially in a recession, whether a group of people have decided that we are going to call this current time a recession or not, honestly doesn’t matter. It doesn’t change anything, right?
Because the broad macroeconomic trends that are underlying our economy that exist today are not exactly new. And whether or not the NBER decides that we are in a recession right now, or maybe in six months, or maybe not at all. I don’t know, but it doesn’t change the underlying facts, right? So let’s review some of those underlying facts. One inflation is outpacing wage growth. And as we’ve discussed has led to a decline in real GDP.
Economic output in the US on an inflation adjusted basis has been down for all of 2022. Whether you want to call this a recession or not, that remains true, and that remains concerning, right? To me, a decline in real economic output is not a good thing. Number two, the stock market and crypto markets are down considerably year to date. I’ve said this before and I want to make a point that the stock market and crypto market or other asset markets are not the economy, but they are part of the economy and they both have been down this year.
That said they have bounced back in July, but they’re still down from early in 2022. So that is a trend that we have been seeing for most of 2022. Whether we call this a recession or not, that is true. Number three, the housing market remains up year over year but is showing signs of slowing. What’s happening in the housing market, the data lines that we’ve been looking at have remained consistent.
Interest rates are going up. Affordability is declining. Demand is going with it and we are starting to see cooling in the housing market. But housing market is still up a lot year over year, but it is showing signs of cooling.
Four, generally speaking, consumer spending remains high. And yes, a lot of consumer spending increasing is a reflection of raised prices, right? So if people are just buying the same stuff and they’re more expensive, of course, consumer spending looks higher because everything costs more. But it is notable that even despite inflation and people spending power going down, they are still spending. So that is an important thing to note and has buoyed some particular retail businesses.
Some businesses continue to show good profit and strong growth. And lastly, the labor market remains strong. And it is true that the labor market, generally speaking, if there is a recession is a lag indicator. And if there is a protracted decline in real GDP, the labor market will probably take a hit. But as of this recording, I’m just looking at the data that I have today, as of this recording, that has not happened yet. Based on basically all the traditional measures of labor out there, people are highly employed right now.
I know there’s people who are going to point to labor force participation and that has declined. That is true. It is a very small amount. It is declined about 1%. So it’s really not that significant. And honestly, if you look at it by most traditional measurements, unemployment is really low right now.
So all these things, there are many other economic factors we could talk about, but these are the ones I just wanted to point out. And if you look at all of these things, like I said, they are true whether or not we call this a recession.
All these things, they can change. They are going to change. All this economic data is released at least a month ago. As of recording, I’m looking at June data for the most part. But these are the economic factors that we know about. And if we’re going to analyze our investments, if we’re going to analyze the market and try and make wise decisions based off it, we need to use the data that is available. And this is the data that is available to us right now.
So all of this is to say that I would advise you not to get too hung up on the definitions here, right? If you understand the underlying forces that are driving the economy, some of the things that I just talked about, then the label of recession, it matters very little, right? If you understand what’s going on with interest rates, the housing market, the stock market, inflation, the labor market. Then what a couple of people decide whether to call it a recession or not, it doesn’t really matter because you’ll be able to make informed decisions about your own financial life.
The fact remains the US economy is not growing on an inflation adjusted basis. And Americans generally speaking are not feeling very good about the economy. Consumer sentiment is extremely low. People are afraid of inflation, and these are the things, at least to me, that really matter. So that, sorry, is my rant about definitions. I just see so many people… Well, I feel like they’re wasting their time just arguing about whether in a recession or not, when really what you should be looking at, and what really matters is the underlying things that impact a recession like GDP, labor market, asset prices, interest rates.
These are the things that we talk about on the show and that I encourage you to pay more attention to than whether or not we are officially in a recession. Sorry, that’s my rant. So, anyway, as I said at the beginning of that I don’t care too much about the definition. What I care about is that declining real GDP is a concern. I wanted to share some historical data about that because I look at that data and I think that’s an economy and decline. I don’t want anyone to panic because recessions happen. That is part of a normal economic cycle.
I just want to share some information about you about what a normal, “recession” looks like. So I looked at some data since World War II and the average recession lasted about 11 months. Not so long. That was actually shorter than I thought it would be. If you’re someone who thinks we are in a recession right now, you follow the two consecutive quarter rule, we’re already at six months, right? Cause Q1, Q2.
So hopefully that means that it might end towards the end of this year. I don’t know. Just something to think about. Interestingly, I also found out that the most recent two recessions that we’ve had in the United States have been outliers. 2020 was the shortest ever recession lasting just two months. So again, that defies the two consecutive months of GDP rule.
It was just two months long. And then the gray recession was an outlier in the other way. Unfortunately, it was the longest post World War II recession and lasted about 18 months. If you look at the severity of these, they really do very pretty considerably. So if you look at the 2001 recession, which again was like the dot com bubble burst, again, it started in March 2021. Only announced in November 2021. And from the peak, the peak of the economy before the recession to the trough, which is the low of the recession, real GDP declined, but it was less than 1%.
So that’s about what we saw in Q2. And so back then, that was a pretty shallow recession. And the stock market took an absolute beating during that time. But real GDP declined less than 1%. And most notably for people listening to this episode, housing prices actually went up over 6% during that recession. So there you go. Pretty interesting. The great recession started in December 27th, 2007. Wasn’t announced for a year after that. And during that time, GDP went down more than 4%.
So that was much more significant recession, as we all know, by most economists and historians standards. The great recession was the worst economic period since the great depression. During that time, the housing prices dropped almost 20%. And as real estate investors, this is the horrible period that a lot of people remember and are afraid that it’ll happen again.
But just to be clear in four of the last six recessions, housing prices actually grew. And so just on an average basis in recessions, that housing prices typically do not go down 20%. And the reason, in my opinion why housing prices went down so much in the great recession is because housing caused that recession, right? In this economy, in this potential recession, housing is not causing it, right? Inflation is mostly causing this one.
So when housing caused the recession back in 2007, there’s a reason housing prices went down so much. That is why personally, I don’t believe even if we are in a recession that we are going to see housing prices decline anywhere close to 20%. I do think that in certain markets we will see housing prices declines, but I don’t think we are really anywhere close to what we saw in terms of macroeconomic conditions around the great recession.
Lastly, I’ll just talk about it quickly because it was barely a recession, but the COVID recession started in February 2020, was announced a couple months later. Only lasted two months and we all remember what happened there, right? The stock market tanked. I think it went down about 30% and then it bounced back quickly and went on an enormous bull run.
Similarly, housing market. It didn’t go down, but the start of this recession, the COVID recession was actually one of the beginning of one of the most aggressive, fastest periods of housing appreciation in American history. So I’m telling you all this because we call this recession, we want to call it a recession, but every recession looks really different. That is part of the reason why it’s hard to define, but it also is part of the reason why the recession label doesn’t matter as much as the underlying fundamentals, right?
What matters is what’s going on with the housing market? What matters is going on with the stock market, with interest rates, with consumer spending, with wage growth, right? These are the things that actually matter. So I obviously can’t say what’s going to happen next, but I wanted to share this information at least because history can be a useful guide for us. And that’s at least what happened over the last three recessions. If you want to look up more, you can just Google it. There’s tons of information about previous recessions that you can look at as well.
Now, we don’t know what’s going to happen, but there are some things that I think are important to watch. And here are a couple things that I personally am going to be watching over the next couple months to get a sense of my own investing but what is likely to happen in the economy.
So what to watch for first thing is employment. The real thing that’s scary about recessions is the unemployment rate rising. As I said earlier, right now the most recent data we have, unemployment is still super low. I am personally curious to see that if we have a sustained period of real GDP declines will unemployment go up? And the reason why I’m thinking about this is because, one, interest rates are going up, which makes it more expensive for businesses to borrow, which means it costs them more to expand, to build the new factory and to hire the people who are going to build stuff in that factory has become more expensive.
Second, if real GDP is down and corporate profits take a hit, they’re less likely to invest. They’re probably not going to raise salaries at the same rate that they have been. And maybe they’ll stall on a couple of new hires or maybe they’ll freeze hiring altogether. I think whether in a recession or not, it is a little too early to understand what is going to happen to the labor market right now.
Right now, it still looks really good, but we don’t know what’s going to happen over the next couple months. And so that’s why it is my number one thing I am going to be keeping an eye on is unemployment rates. The second thing is of course, inflation.
Now, many forecasters are projecting that inflation has actually peaked. And listen, this is not my area of expertise. I don’t have economic models or statistical models to project inflation, but I do follow a lot of different economists from all different types of backgrounds and beliefs. And if you look at commodity prices, this seems plausible.
You look at food prices, you look at energy prices, they are starting to come down. And a lot of that is because of fear of an inflation, but there is a plausible path that inflation has peaked. Now, that does not mean that prices are going to go down. That is just not going to happen. But what it does mean is that inflation may grow less fast, right? We’ve seen it at high eights, 9%. Maybe it goes down to 8% year over year. And then by the end of the year, maybe it’s 7% year over year.
I don’t know. This is just what people are… The majority of economists believe that it is going to start going down. That doesn’t mean the problem is going away because even if it goes down to 7%, 7% is still bad. But it would be a good sign for the economy if it peaked and started to decline. So that is something to watch for because, I guess, the point is if inflation starts to come down and employment, the other thing I’m looking at remains relatively strong, if those two things do happen, then we’ll probably see real GDP and economic confidence start to improve probably towards the end of this year.
If that doesn’t happen and inflation remains high, and we start to see large scale job losses, then we are at risk for a longer term recession and more economic pain. Maybe not quite at the scale of the great recession. I don’t think we’re really looking at something like that, but there is a scenario where this is a short and shallow recession and there is a scenario where this is more of a protractor recession. Personally, I think it is too early to tell one way or another, but these are the things I’m going to be looking at.
The last thing is of course interest rates. I do think this is honestly maybe the most interesting thing that may come of this GDP data that came out is that the federal reserve has obviously been raising interest rates since March in an effort to combat inflation. They’ve been very clear that they’re going to keep doing that. They’ve raised rates by 75 basis points. Two times in a row right now. That is very significant. But the fed also doesn’t want to crater the economy.
Officially, their job is to secure price stability, basically fight inflation and to pursue maximum employment. And if recession comes… And it’s a long recession, like we just talked about employment could start to go down. And so that will put the fed in a really interesting spot where they can’t just be aggressive against inflation because if employment starts to fall, then they have to decide, right? They have to do this balancing act of how do they fight inflation while keeping employment as high as possible.
So that could mean that the fed reverses course a little bit. Now, I don’t think we’re at the point where they’re going to start cutting rates, but my expectation is that they will probably start raising rates slower. And this is just my opinion. I am just speculating here. I think we’re not going to see any more 75 basis points hikes. I think we’ll probably see a 50, maybe 25 basis points hikes through the rest of the year.
A lot of people believe that the fed could start cutting rates in 2023. I don’t know about that. I am not projecting that, predicting that, but people have been talking about that. A lot of people on Wall Street believe that might be the case. So those are things to look at. My top three are employment rates, inflation and interest rates.
Okay. So quickly before we go, I just have a couple of notes and things to point out for real estate investors based on this announcement. First and foremost, as I said before, housing prices have actually risen in four of the last six recessions. And so don’t just assume that there’s going to be a crash because there is a recession. There is a lot more going on in the housing market than just whether GDP is going up or down.
We try and cover this extensively here on this podcast. And you can listen to a lot of our recent episodes if you want to learn more about that. I’m not going to get super into that right now. But lot of episodes. You can listen to one with Logan Mohtashami, Rick Sharga, one we just did with the whole panel. Just talking about what’s going on in the housing market will help you understand what might happen next.
The second thing is that, although, the fed is raising interest rates. The fed does not control mortgage rates. I say this all the time, but I want to just hammer this home. The fed does not control mortgage rates. Rates are much more closely. Mortgage rates are much more closely tied to the 10-year treasury yield, right? So go look on whatever financial data website you like. Go look at the yield on a 10-year treasury.
It peaked back in June and it is starting to go down. In a historical context, it is still extremely low. Now, why is this happening? And just for the record, the yield on the 10-year treasury is starting to decline and that has moderated mortgage prices very considerably.
Now, why is this happen? Well, it’s because of fear of a recession. When there is fear of a recession, investors, generally speaking flock to safer investments. They don’t take as much risk. You see that reflected in really risky stocks, right? They’re getting hammered more than blue chip stocks, for example. So investors flock to safe investments and treasury bonds like the 10-year yield, the 10-year treasury, excuse me, that I am talking about are extremely safe investments because they’re guaranteed by the US government.
So all these people are looking for these bonds because they’re safe and that raises demand, right? There is demand for bonds and it does with everything else, and it’s supply and demand. When there is more demand, prices go up. And the funny thing about bonds just… I’m not going to get super into this. I will do a full episode soon, but when prices for bonds go up, they’re yields fall. They’re inversely correlated.
So demand is up. That increases the price for bonds that pushes down their yields and that means that mortgage rates have gone steady. They’re down from their peak. I don’t know what’s going to happen, but if you are looking to buy real estate, look at what’s going on right now. And you can see that bond yields are a bit lower. They’re not going back to… We’re not going to get 3% mortgages again. We’re not going to get 4% mortgage again anytime soon, but they have stopped growing so quickly and we are starting to see five and a half, 5.75 be the standard right now.
They’re no longer on this like exponential rise that we saw for the first half of the year in mortgage rates, they’re starting to flatten out. And to me, this is really important because it provides more stability to the housing market, right? Investors, homeowners, can all start to make informed decisions if they have a good idea of where mortgage rates are going to be over the next six months or during at least during their buying period.
So that is something to also keep an eye on is mortgage rates because, again, just to reiterate here, although the fed is raising interest rates, fear of a recession is pushing down bond yield and that constrains mortgage rates.
Okay. So that is what I got for you guys. Just to recap, the US is seeing declining output on an inflation adjusted basis. We now have seen real GDP decline for two consecutive quarters. Most people consider this a recession, but we won’t know if it’s officially a recession for at least a few more months.
My personal advice, don’t get too caught up in the definition of a recession. It is the underlying economic forces that matter. Inflation is far too high. Spending is keeping up. We have not yet seen a large scale job losses, but that is going to be a key thing to watch in the coming months. And the housing market is cooling on a national scale, but still up double digits year over year which in any other year would be absolutely massive.
As an investor, you should be understanding all of these forces. That is my recommendation to you. Again, don’t get too caught up into whether we are in a recession or not, whether we’re calling it a recession or not. Try instead to understand the underlying economic forces. This is what this show is all about. Our aim is to help you understand the important trends and data points that have led to the economic conditions we find ourselves in and not get caught up into what words we use to describe them and into some debate that is ultimately going to be settled by a couple of academics a few months from now.
So hopefully, we’ve done that today and we’re going to keep trying to do that twice a week to help you understand the complex economic situation we find ourselves in. Thank you all so much for listening. We really appreciate it. If you have any feedback for me or thoughts about this episode, please reach out to me on Instagram where I am @thedatadeli. Thank you all. We will see you again on Monday.
On The Market is created by me, Dave Meyer and Kailyn Bennett. Produced by Kailyn Bennett. Editing by Joel Esparza and Onyx Media. Copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team.
The content on the show, On The Market are opinions only. All listeners should independently verify data points, opinions, and investment strategies.