Understanding Recessions: What They Are and How to Prepare

Recessions are an expected part of the economic cycle, representing a period of economic decline that follows expansion. Recessions can be scary but knowing how they work and why they happen may help you handle them better.

What Is a Recession?

A recession is a sustained period of economic downturn, marked by declining economic activity across multiple sectors. It is one of four phases in the economic cycle: expansion, peak, recession, and trough.

Economic growth does not always go straight up. History shows that times of growth last longer than recessions. The U.S. has recovered from every recession it has faced.

In the U.S., the National Bureau of Economic Research (NBER) is responsible for determining if we are in a recession. It evaluates factors such as real income (adjusted for inflation), employment levels, industrial output, retail sales, and gross domestic product (GDP). Typically, these indicators must decline for an extended period before a recession is officially declared. However, exceptions exist—such as the brief two-month recession in early 2020 triggered by the COVID-19 pandemic.

Recession vs. Bear Market: What’s the Difference?

Recessions and bear markets may get confused but refer to different economic conditions. A recession is when the economy shrinks. A bear market is when the stock market falls by 20% or more. Although a bear market and a recession can happen at the same time, , a bear market does not always mean a recession is coming. Also, a recession does not always lead to a bear market.

What Happens During a Recession?

When the economy contracts, it may trigger a domino effect. Businesses may struggle, which may lead to job losses and lower consumer spending. This reduced demand can further weaken business performance and negatively impact financial markets. In extreme cases, a prolonged downturn may even lead to deflation, where prices fall due to decreased consumer spending.

Governments and central banks often step in to help stabilize the economy. They may use strategies like changing interest rates, increasing public spending, or applying stimulus measures with the hopes of boosting growth.

What Causes Recessions?

There is no single cause for every recession, but some common triggers may include:

●      Economic Shocks: Unexpected events like wars, financial crises, or pandemics can create uncertainty. This uncertainty can make businesses and consumers spend less, which leads to a smaller economy. The COVID-19 pandemic is a recent example of such a shock.

●      Bursting Asset Bubbles: When industries experience rapid, unsustainable growth, they can form asset bubbles. If these bubbles burst, like the dot-com crash in the early 2000s or the 2008 housing market collapse, it can lead to a recession.

●      Overheating Economies: When economies grow too fast, it may raise inflation. This makes goods and services more expensive. As a result, businesses may cut costs by laying off workers and reducing investment. This may ultimately cause economic contraction.

How Long Do Recessions Last?

Historically, recessions have occurred about every 6.5 years and typically last around 11 months. However, their durations can vary. The Great Recession (2008-2009) lasted 18 months, while the COVID-19 recession in 2020 was the shortest on record at just two months.

Recession vs. Depression

Concerns about recessions may lead to fears of a depression—a much more severe and prolonged economic downturn. There is no exact definition of a depression. However, it usually means a long period of serious economic decline. This decline can last for several years, like the Great Depression in the 1930s.

How to Prepare for a Recession

While it is hard to predict recessions with certainty, you can take steps to potentially protect your finances:

●      Build an Emergency Fund: Having a financial cushion can help cover expenses in case of job loss or unexpected financial strain.

●      Maintain a Strong Professional Network: Staying connected within your industry can improve job security and potentially provide career opportunities if needed.

●      Stick to a Long-Term Investment Plan: Market downturns can be unsettling, but a well-diversified portfolio designed for the long term may be able to help weather economic turbulence.

Final Thoughts

Recessions are an inevitable part of economic life, but they are temporary. By understanding their causes, impacts, and strategies for preparation, you may be in a better position to navigate them with confidence. History has shown that economic downturns are followed by recovery—staying informed and proactive is the best way to ride out the storm.

Sources:

https://www.fidelity.com/learning-center/smart-money/what-is-a-recession

Disclosures:

This information is an overview and should not be considered as specific guidance or recommendations for any individual or business.

This material is provided as a courtesy and for educational purposes only.

These are the views of the author, not the named Representative or Advisory Services Network, LLC, and should not be construed as investment advice. Neither the named Representative nor Advisory Services Network, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information.