The Next Recession: Bernanke’s Views on 3 Likely Causes

Time to Read: 7 Minutes

In July 2019, the US economic expansion crossed the 121-month mark, stealing the crown for the longest uninterrupted stretch of post-war growth from the economic boom of the 1990s. As the expansion—now in month 127—continues to grow longer, our clients have been asking, “When will the next recession occur?”

Analyzing the expansion: Length vs. strength

A few months after our expansion set the new record, I was fortunate enough to attend a roundtable discussion with former Federal Reserve (Fed) Chair Ben Bernanke, where he was faced with the same question. He answered in two parts. First, he noted that, while the current expansion is the longest on record, it is also the weakest. The charts below illustrate his point, showing the length of each post-war expansion along with its average annual GDP gain. We see that the current expansion is longer than the boom of the 1990s, but it is weaker, posting a 36% slower growth rate.

What kills an expansion? Inflation, deteriorating credit conditions and geopolitics

Second, Mr. Bernanke noted that expansions don’t die of old age—they’re typically “murdered.” He identified three culprits responsible for the demise of an expansion:

1. Inflation – When inflation accelerates, the Fed is forced to raise interest rates to cool the economy, a scenario that has caused several recessions. In our view, inflation poses very little risk to the current expansion. In fact, Fed Chair Jerome Powell recently testified that inflation has been low and stable, running below the Federal Open Market Committee’s symmetric 2% objective. Below-target inflation was a key reason behind the Fed’s 2019 rate cuts.
2. Deterioration in credit conditions – Credit is the lifeblood of an economy and when it dries up, it can trigger a recession. For evidence, look no further than our most recent recession: In 2008, credit conditions not only deteriorated but collapsed dramatically enough to cause a worldwide financial crisis and global recession. Today, credit conditions in the US remain favorable, with credit flowing and consumers in much better shape than they have been in years.
3. Geopolitics – Economic growth can be hindered by international affairs such as major military escalations, trade wars and perhaps the new coronavirus. Unfortunately, such events are difficult to predict, making them a challenge to navigate. Currently, geopolitical risks look to be the most serious of the three potential expansion killers. The good news? The US economy is still expanding despite a multi-year trade war. As far as the novel coronavirus, it’s still too soon to fully gauge its economic consequences—but historical analysis has shown that global health emergencies typically have just a short-term impact on markets, a topic we recently explored.

Review your risk

Although we feel recession risk is relatively low, we caution investors from being overly complacent when it comes to a potential market correction. It’s critical to recognize that the US stock market has not experienced a 20% correction on a closing basis since the start of the current expansion. The chart below illustrates this noteworthy streak, revealing that the S&P 500 Index has gone a whopping 2,753 days without a 20% correction—much longer than the mean of 635 trading days (roughly 2.5 years).

Based on our indicators, we feel the current expansion has room to continue—but we also believe that a correction has a greater likelihood of occurring before the next recession, as would be expected during a normal investing cycle. Should this occur while the economy is still expanding, we would likely view it as a buying opportunity.

In light of this conversation around a potential correction (or eventual recession), we believe investors should review their allocations to ensure alignment with risk tolerances. Clients of Stratos Private Wealth benefit from our regular, comprehensive strategy assessments—which include our Risk Audit—designed to test the relationship between investment portfolios and feelings about risk.