Recessions, Inflation, and Markets

July 8, 2022

Are we in a recession or heading towards one? This is a fairly straightforward question without an easy answer. The textbook definition of a recession is two consecutive quarters of negative real (inflation-adjusted) GDP growth. By this definition, a recession is all but certain, as we had negative real first quarter growth and the second quarter looks to be the same. However, that’s not the only consideration. In order for a recession to be “official” in the US, the National Bureau of Economic Research (NBER) has to declare it as such, even if the textbook definition is met.

The real part of the definition is very important, as it signifies that economic growth is adjusted for inflation to determine if a recession is underway. To illustrate this, Q1 2022 had current dollar growth of 6.6%, but due to inflation running at ~8%, the real growth was negative (6.6% - 8.2% = -1.6%). Q2 is facing a similar scenario, with the Fed again forecasting negative real growth with inflation around 8% (thus another quarter of strong current dollar growth that becomes negative real growth after the inflation adjustment). Since second quarter data isn’t finalized yet, let’s take a look at this impact in Q1:

Source: Gross Domestic Product (GDP) | FRED | St. Louis Fed (
Source: Real Gross Domestic Product (GDPC1) | FRED | St. Louis Fed (

As you can see in the second chart, the line has the slightest down slope once adjusted for inflation. What this creates is a very unusual situation where the textbook definition of a recession could very well be met once Q2 growth is published, without the usual hallmarks of recessions: job losses, significant decreases in economic activity, and wage reductions. To take this a step further, try booking a flight, hotel, rental car, or wedding venue and let me know how that goes – it should be easy to find good deals on this stuff as we are in a recession, right? Maybe a new term is needed - Recession light? Recession in name only? Feel free to send us a few ideas.  

This begs the question: Do we need to change the textbook definition of a recession?

In short, no. Measuring growth with an inflation adjustment is prudent, if not necessary, to properly gauge economic activity. However, even ideal methods of measurement can run into issues when things get a little crazy, especially if inflation is that crazy thing. The reason inflation can cause so much havoc is twofold:

  1. The higher the level of inflation, the harder the economy has to work to generate positive real growth.
  2. Higher levels of inflation tend to accompany higher inflation volatility – meaning when inflation is high, it’s much harder to predict with accuracy where inflation will be in the coming months/years. This can stifle major investment initiatives as businesses have difficulty forecasting and hedging costs.  

The following chart illustrates this well, showing the high level and volatility of inflation in the1970s compared to the low level and volatility of inflation in the US the past 30 years:

Source: Inflation, consumer prices for the United States (FPCPITOTLZGUSA) | FRED | St. Louis Fed (

Gazing into the crystal ball, the big question is regarding inflation more than economic activity. If inflation continues to run in the 6-9% range, then this recession may very well go from “recession-light” to “recession-heavy” as costs become too high for consumers to bear, and businesses slow or stop capital expenditures due to forecasting difficulties. While this scenario seems questionable, it is a possibility that shouldn’t be ignored.

Oil prices are also a huge factor in consumer spending and overall inflation, as oil touches almost every facet of the economy. While oil is off from its highs ~30 days ago, uncertainty around supply will likely persist.

As is the case with most things, some nuance is needed in the conversation around recessions as well, which will surely be missing from the soon-to-come articles (and political bloviating) touting “A RECESSION IS HERE!” As investors, you have to look at the term recession on a spectrum with various shades of gray versus the black & white framing of “Are we in a recession or not?”

What should Investors do moving forward?

Russell Investments looked at recession data from 1869 – 2018 and found that, during the 30 recessions that occurred in this 150-year period “the correlation between GDP growth and U.S. stock-market returns is nearly zero: -0.05.” Equally important, this study found that, in order to beat a “buy and hold” strategy by market timing, an investor needs to successfully predict almost 80% of market turns correctly, theoretically possible but extraordinarily difficult in reality. And while the textbook definition of a recession is likely to be met, I have doubts about whether the NBER will actually declare a recession due to the robust economic data excluding negative real growth. We could very well be experiencing the "recession that was, but wasn't."

Regardless of recession vs. no recession, the most important things to do as investors make certain you have an appropriate allocation to weather market volatility and have a written plan for how to navigate downturns. As difficult as it may be, tuning out the noise and sticking to your plan gives you the best chance for earning a positive return in the long run.


This material has been prepared for informational purposes only and should not be used as investment, tax, legal or accounting advice. All investing involves risk. Past performance is no guarantee of future results. Diversification does not ensure a profit or guarantee against a loss. You should consult your own tax, legal and accounting advisors.

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