What We Can Learn From Historical Recessions

The U.S. economy contracted in the first and second quarters of 2022, meeting the technical definition of a recession. But a healthy job market largely prevented the National Bureau of Economic Research from calling an official recession. Is that about to change?

Stubbornly high inflation, rising interest rates, massive federal debt, shrinking corporate profits and ongoing supply chain constraints are all factors on their own that could slow economic growth. Add the backdrop of geopolitical unrest and turbulent markets, and the potential increases that the U.S. tips into a recession.

No one has a crystal ball that can predict the financial future. However, we have a clear view of the past. We can use historical insight as a tool to inform current decision-making about managing our finances.

How Are Recessions Characterized?

It’s important to note that economists can only identify when we’re already in a recession, not when we’re heading into one. Economists at the National Bureau of Economic Research  do not characterize a recession simply as two quarters of decline in economic activity. A number of factors could be involved, including:

• Decline in the gross domestic product (GDP).

• Slowdown in consumer spending.

• Falling consumer confidence.

• Drop in asset prices.

• Rising layoffs.

Historic Recessions and Their Causes

There’s a long history of recessions in the U.S., and each one has its own causes, length and recovery. One of the earliest recessions in the U.S. was the Panic of 1797. It was caused in part by the increase in the supply of money through the 1790s under Treasury Secretary Alexander Hamilton. A speculative investment bubble in land and capital-intensive projects followed and ultimately burst, leading to personal bankruptcies and business failures.

There have been many since then, but we’ll outline the two most recent historical U.S. recessions.

The Great Recession

• Length: Late 2007 to mid-2009—the most protracted recession since the Great Depression.

• Primary cause: A key factor revolved around the collapse of the housing market due to subprime mortgage lending.

• Recovery: The passing of the American Recovery and Reinvestment Act  in early 2009 helped stimulate the market. The U.S. showed its first signs of recovery in mid-2009 when the GDP  grew at an annual rate of 2.2% in the third quarter after it had shrunk 0.7% in the prior quarter.

2020 Recession

• Length: One year.

• Primary cause: COVID-19 and the subsequent shutting down of daily life were primarily to blame for the 2020 recession. While the recession was technically just a year, it was one of the steepest plunges, with the economy shrinking by over a third  in the second quarter of the year.

• Recovery: Over the course of the year, the government passed multiple stimulus bills to bolster consumer confidence and spending amid the instability. In addition, the widespread distribution of vaccines helped spur recovery. By the fourth quarter, the GDP grew, signaling recovery.

From the past two recessions alone, there’s a lot to sort out. We may not be able to predict a recession’s length or extent, but there are ways to prepare your investment portfolio to account for the economy’s ups and downs.

How Can I Prepare My Portfolio for a Recession?

Key to navigating a downturn is to prioritize strategic diversification. Portfolios with different types of investments may fall less during downturns and recover sooner.

Periodic portfolio check-ins to rebalance your portfolio can also help keep you on track. Some investments may perform better than others, and your portfolio can become misaligned, which could expose you to more risk than you expected.

Professionally managed asset allocation portfolios offer a mix of funds that cover multiple asset categories in a single product. Importantly, fund managers will carefully select and monitor the investments in these portfolios for their shareholders.

While we’re all experiencing the same economy, not everyone has the same tolerance for risk or timeline for investments. But in times of uncertainty, avoid knee-jerk reactions to the market. Spur-of-the-moment decisions for an existing plan are rarely the best way to reach your goals and objectives, and that’s true especially in volatile times.

What We Can Learn From Past Recessions

No two recessions are precisely the same, but by understanding the past, we can take important economic lessons into the future. And one lesson is clear: Markets can change quickly.

It’s important to be comfortable with your plan and your emotions in the face of uncertainty. We can help you determine what's appropriate for your needs, so you can be ready for what's ahead.