Is the U.S. economy in a recession? This question has been the subject of debate recently as investors assess the state of the economy and as politicians on both sides of the aisle seek to shape the public narrative ahead of the upcoming mid-term elections.
To answer the question, we first need to define what a recession is. There are two common definitions. The first is a technical definition: two or more consecutive quarters of falling GDP. This definition has the advantage of being straightforward and objective. If economic activity is receding, then the economy is in recession. Thus, after GDP fell last quarter for the second quarter in a row, many commentators declared the economy to be in a recession.
The drawback of this definition is that it attempts to distill the U.S. economy into a single data point, which can be inadequate and misleading. For example, GDP contracted in the first quarter primarily because Americans spent so much on imported consumer goods. This increased the trade deficit, which detracts from GDP. Thus, it’s fair to say GDP contracted in the first quarter due to technical factors and not necessarily due to economic weakness.
A second definition of a recession is provided by the National Bureau of Economic Research (NBER), an academic think tank that many economists look to as the official adjudicator of when businesses cycles begin and end. The NBER’s definition of recession is, “a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and retail trade.” This definition has the advantage of evaluating the economy in a nuanced, holistic way. For example, over a half-million jobs were added to the economy in July, which is hardly characteristic of an economy in recession, regardless of the official GDP statistics.
On the flipside, this approach to defining recessions is subjective and open to interpretation. Furthermore, the NBER often takes many months or quarters to declare a recession, thus rendering its pronouncements of little use to investors.
For investors, what matters is not an academic debate over what constitutes a recession, but rather what the economic environment means for corporate profits. To that end, profits continue to be quite strong, either because of or despite the state of the economy. With nearly 90% of S&P 500 companies reporting earnings for the second quarter, profits are up nearly 9% year-over-year, which is 4% better than Wall Street analysts expected. Corporate revenues are up nearly 15%, which is also better than predicted.
In conclusion, the answer to whether the U.S. economy is in recession depends on your definition. GDP has contracted for two quarters, which by one measure qualifies as a recession. However, the slowdown has not been enough to derail corporate profits. And if we are in the midst of an NBER-style broad based recession, there is little sign of it in corporate results.