Never let the future disturb you. You will meet it, if you have to, with the same weapons of reason which today arm you against the present
Study the past, if you would divine the future
There have been times during the past couple of weeks where it feels like I am taking crazy pills, particularly when it comes to the market. The market had a historically precipitous drop, has recovered significantly in the face of record unemployment and GDP forecasts and remains every bit as volatile as we have ever seen. It has tested the convictions of many people and has brought up some great question in conversations with clients and others. I will try to address a couple of those in this week’s ‘Inside Look at Building Towards Wealth’.
-What is the difference between a recession and a depression?
A recession, generally, is defined as a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters. The National Bureau of Economic Research has a wonkier definition here. Either way it is a decrease in GDP which is usually accompanied by decreases in real income, employment, industrial production and retail sales, generally for several months.
A depression, I have found out to my surprise, has no standard definition. The popular intermediate macroeconomics textbook, written by Gregory Mankiw, states it as “There are repeated periods during which real GDP falls, the most dramatic instance being the early 1930s. Such periods are called recessions if they are mild and depressions if they are more severe.”
As Mankiw pointed out, perhaps the most famous economic downturn in the U.S.’s (as well as the world’s) economic history was the Great Depression, often described as starting in 1929 and lasting at least through the 1930s and into the early 1940s, a period that actually includes two severe economic downturns. Using the NBER business cycle dates, the first downturn of the Great Depression started in August 1929 and lasted 43 months, until March 1933, far longer than any other twentieth century contraction. The economy then expanded for 21 months, from March 1933 until May 1937, before suffering another downturn: from May 1937 until June 1938, a period of 13 months, the economy again contracted.
A depression is just a prolonged severe recession.
-Are we going to go into another depression?
While nobody can answer with certainty, we can look at the similarities an difference between now and the Great Depression which is our nearest reference point. It’s important to note I don’t know how bad things will get as our economy has never been halted like this before. I’m optimistic that there will be a significant recovery on the other side once things get back to normal but there are no guarantees.
Today, the Federal Reserve is a well-established government entity, having been in existence for over 100 years. During the depression it had been in existence for less than two decades and the members were, in retrospect, bad at their jobs. They accelerated the speculative times before the crash and they did almost nothing to stop it as it unfolded.
The modern Federal Reserve has acted quickly and decisively to avert disaster. Central banks around the world have pumped liquidity into system helping keep the giant machinery of the financial markets lubricated and running somewhat efficiently. This did not happen during the Great Depression and was a contributing factor to run on banks and huge number of bank failures.
Next we should examine government spending. In 1932, in the midst of the depression the consensus was to shrink the government. Both sides of the aisle aimed to cut 25% of the budget. Compare that to today where we have spent $2 Trillion in rescue funds and another $4 trillion in loans. There are already discussions in congress about the NEXT package which could be trillions more. It is a staggering difference in the approach and amount of money being used to combat this problem.
A few government programs came out of the depression era. Medicaid & Medicare, social security, FDIC insurance and unemployment insurance all did not exist during the Great Depression. I will skip the arguments about the pros and cons of our social safety net. We can all agree it is significantly better than what was available during the Great Depression. The lack of any safety net significantly changed the savings and spending habits for the generation to follow. We will see if having these programs in place will accelerate people returning to “normal” spending habits on the other side of this.
Finally we look at the financial markets. They are just a different beast today then back in 20’s and 30’s. In the early 20’s 1% of the population owned stocks and the use of margin and manner of trading more closely resembled that of a casino than the modern markets. Today it is 54% of Americans that own stocks (Gallup) and we have pension funds, periodic contributions in 401k and IRA’s, rebalancing strategies and diversified portfolios that all contribute to greater stability in the market.
What’s going to happen in the next 12-24 months?
The honest answer is I don’t know and nobody else does either. Everybody else who tells you with certainty is just passing off their guess as fact.
Will some of those predictions be right? Absolutely there will be some that are right. Someone has to be right and I’m pretty sure I have heard every opinion imaginable about what the next couple years hold. What I can say is that the S&P 500 from 1979-2018 was up 86.1% of the time over any 5-year period an 93.5% of the time over any 10 year period (Source: Thomson Reuters, 2019, for the period January 1, 1979, to December 31, 2018).
We have weathered world wars, pandemics, terrorist attacks and everything else and each time the market has been higher after those events. If you have a big purchase planned or need to spend money in investments in the short term (next 24-36 months) it is reasonable for that to be sitting in cash. Investing is generally done with a long-time horizon in mind. Even someone who is 45 is investing with a time frame of 4 or 5 decades and historically the market tends to rise over longer periods of time.