Hooray! We are now in the longest period of economic expansion in U.S. history (June 2009 to present), having recently surpassed the prior record of March 1991 to March 2001^1 The last two recessions were especially painful in the equity markets due to excesses built during the expansion that created significant imbalances. It is no wonder a number of people are displaying what you might call “a fear of economic heights” as the current expansion continues. So, we would like to share a few perspectives on economic expansions and recessions.
First, in our view, there is no reason a recession must occur. Economic expansions are driven by increases in the population and the effects of new technologies. So far, the population has always grown, and technological innovations are always in the works. As the economy expands, additional money needs to be put into circulation to maintain the viscosity of the financial system. 350 million $1 bills might be plenty for a population of 100,000 to conduct business, but it would not be enough for a population of 350 million. As long as an approximate balance between people, things, and money is maintained, there is no reason to expect a recession would occur. Economic expansion is the norm.
There is frequent discussion about “economic cycles,” but the word “cycle” is a bit of a convenient misnomer. Historically, there has not been very much that is truly cyclic. Economic expansions and recessions have occurred at irregular intervals, have lasted for varying lengths of time, and had varying amplitudes with respect to their growth rates. Additionally, recessions have been precipitated by varying sources.
Before the information age, the economy could be viewed as a lever where high growth created excesses and imbalances, which were corrected by a recession. In Boom times, the sectors were all on the growth side of the lever, which pointed to high growth. Eventually excesses would cause a sector to become imbalanced, and it would move to the recession side of the lever, which would point to slower growth. Troubles in that sector would spread to other sectors, and eventually all sectors would be on the contraction side of the lever, which would point to meaningful contraction. As the excesses were worked off in a sector, it would move back to the growth side of the lever. Growth would resume after enough sectors had worked off the excesses and regained balance. Overall economic growth through the turbulent boom, bust, and recovery was only modest.
Visually it might look like this. Xs represent economic sectors.
The charts are intended for the purpose of displaying a visual illustration only
Second, in the information age we live in today, adjustments can be made via real time monitoring of situations, which greatly reduces the chances of imbalances existing for long periods of time. In this century, entire industries have been created to absorb excess inventory, labor, fuel, insurance risk, and host of other things. So far, the information age and transition to a more service-oriented economy (as opposed to the industrial-oriented economy in the middle parts of the last century) has helped the economy remain approximately balanced. With this in mind, it is probably not surprising that the two longest periods of economic expansion occurred in the information age.
Furthermore, since the Great Recession there have been periods in which a major segment of the economy was meaningfully off balance, but it did not tip other segments or the overall economy into recession. What also marks the period since the Great Recession is the fact that most of the sources of imbalance have come from abroad. The U.S. consumers, financial institutions, industrial companies, and energy producers have behaved rationally on balance.
In 2011 there was the European debt crisis. The mild industrial recession in the 2014/2015 time frame was the effect of a slowdown in China. The 2015 Energy Crisis was initiated by Saudi Arabia and caused a profit recession at the end of the year but not an economic recession. From 2016 to present there has been what you might call the “Retail Apocalypse” resulting from the disruption to consumer companies by online shopping. The retail industry employs over 16 million people^2 and uses trillions of dollars of real estate, but the impacts have been largely contained. Obviously, there is a (so far) mild manufacturing recession and a recession in the transportation sector since the trade wars started in late 2018.
The chart is intended for the purpose of displaying a visual illustration only.
Since the Great Recession (so far), it is as if various segments of the economy took turns having isolated recessions which has resulted in a long period of slower than average growth. During this record expansion the economy has grown approximately 2.25%/year or 25%^1 in total. While this rate is less than other periods of economic expansion, the growth over the last ten years has been similar to what one might expect if there were periods of higher growth rates with intermittent interruptions by recessions.
We previously wrote about the need to strike a balance between trade wars being unwinnable versus the need to address misdeeds in China, and how we are starting to see the effects in U.S. manufacturing activity. We are keeping a watchful eye on the interactions between the various sectors of the economy and imbalances within the sectors. The trade war may create the imbalance that leads to the next recession. We fully expect future recessions and recommend all investors plan for them, but we also expect those recessions to end and to return to the norm of economic expansion.
Please do not hesitate to reach out to us, especially if you are concerned about the chances of reaching an economic tipping point or the upcoming election. We welcome all conversations.
Redmond Asset Management, LLC October 2019